WORKS  OF 
WILLIAM   G.   RAYMOND 


Railroad  Field  Geometry  (Without  Tables) 

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Elements  of  Railroad  Engineering 

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Railroad  Field  Manual  for  Civil  Engineers 

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What  is  Fair 
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WHAT  IS  FAIR 

A  STUDY  OF  SOME  PROBLEMS 

OF  PUBLIC  UTILITY 

REGULATION 


BY 

WILLIAM  G.  RAYMOND,  C.  E.,  L.  L.  D. 

Professor  of  Civil  Engineering  and  Dean  of  the  College 
of  Applied  Science  in  the  State  University  of 
Iowa;   Member  of  the  American  Society 
of  Civil  Engineers ;  A  merican 
Railway   Engineering   As- 
sociation, etc. 


FIRST  EDITION 


NEW  YORK 
JOHN  WILEY  &  SONS,  INC. 

LONDON:   CHAPMAN   &   HALL,   LIMITED 
1918 


COPYRIGHT,  1917 

BY 
WILLIAM  G.  RAYMOND 


TO   MEN   WHO   WISH 

TO   BE   FAIR 

IN   THEIR   DEALINGS   WITH 
THEIR  FELLOWS. 


11  And  as  ye  would  that  men  should  do  to  you, 
do  ye  also  to  them  likewise." 

Jesus  of  Nazareth. 


3849-:" 


PREFACE 

This  little  book  should  be  read  in  the 
spirit  in  which  it  is  written.  Because  its 
tone  may  seem  to  some  readers  to  be 
pro-corporation,  it  should  be  said  that 
the  author  has  no  financial  interest, 
direct  or  indirect,  in  any  public  utility, 
and  hi  his  professional  work  he  has  been 
employed  more  often  by  the  public  than 
by  private  interests.  The  book  is  the 
result  of  an  honest  effort,  extending  over 
some  years,  to  determine  for  the  author's 
own  satisfaction  just  what  is  fair  in  the 
relationships  of  the  public  and  the  own- 
ers of  its  utilities.  Always  he  asks, 
"  What  is  fair?  " 

Only  a  few  of  the  many  problems  that 
arise  are  considered,  and  these  only  to 
try  to  develop  fundamental  principles 
that  should  govern  those  having  to  labor 
with  the  details.  The  complete  argu- 
ment as  it  has  worked  itself  out  in  the 

vii 


viii  PREFACE 

author's  mind  is  not  always  given.  For 
some  conclusions  there  has  been  little  or 
no  argument,  such  intuitive  sense  of  fair- 
ness and  justice  as  the  author  possesses 
seeming  to  point  directly  to  the  conclu- 
sion. It  is  realized  that  some  readers 
may  have  a  more  highly  developed  sense 
of  what  is  right  and  fair  and  may  disa- 
gree with  some  of  the  conclusions  reached. 
Be  this  as  it  may  these  pages  are  pre- 
sented as  containing  the  out-loud  think- 
ing of  one  student  of  business  relation- 
ships, who  has  been  trained  as  an  en- 
gineer to  deal  with  facts  and  theories  and 
to  try  to  make  theories  agree  with  facts, 
and  who  is  trying  to  be  fair  in  his  judg- 
ment of  human  questions  that  cannot  be 
settled  by  the  application  of  fixed  formu- 
las. In  this  same  spirit  the  book  should 
be  read.  Let  the  reader  think  question- 
ingly  as  he  reads  and  decide  for  himself 
not  too  hastily  whether  or  not  the  general 
relationships  that  should  exist  between 
the  public  and  its  service  corporations 
are  correctly  stated,  when  the  state- 
ments are  considered  in  the  light  of  gen- 


PREFACE  ix 

erally  approved  honorable  business  prac- 
tices. The  attempt  has  been  to  start 
with  what  is  considered  honorable  deal- 
ing in  purely  private  business  and  to 
work  from  this  to  the  semi-public  busi- 
ness of  the  public  utility. 

Public  ownership  is  not  discussed.  In 
an  Utopia,  government  will  perform  all 
functions  now  regarded  as  public  func- 
tions and  many  that  are  now  regarded  as 
purely  private  functions.  We  do  not 
live  in  Utopia.  Therefore,  Utopian  con- 
ditions should  not  form  the  basis  of  any 
reasoning  with  respect  to  present  business 
relationships.  Only  what  is  generally 
conceded  by  this  day  and  generation  to 
be  fair  and  honorable  in  business  dealings 
should  govern  these  dealings.  Therefore, 
it  is  to  the  men  of  today,  particularly 
those  having  to  do  with  the  problems 
of  today  under  the  conditions  existing 
today,  that  the  thoughts  on  these  few 
pages  are  addressed,  in  the  hope  that 
though  not  new,  their  formulation  may 
be  suggestive  and  possibly  helpful  in  the 
solution  of  some  of  the  many  troublesome 


x  PREFACE 

questions  now  vexing  utility  owners  and 
commissions,  legislative  bodies,  courts, 
and  interested  business  men. 

As  a  result  of  the  war  now  in  progress, 
certain  advances  may  be  made  by  gov- 
ernment in  the  regulation  of  the  business 
of  furnishing  food  and  fuel,  and  possibly 
in  other  lines.  Such  advances  will  in  no 
wise  affect  the  general  argument  of  this 
book  which  is  intended  to  lead  to  these 
general  conclusions: 

1.  That  so  long  as  public  service  is 
turned  over  to  private  owners  and  oper- 
ators, the  provisions  of  the  charter  and 
franchise  of  every  public  utility  should 
be  as  complete  and  definite  as  it  is  pos- 
sible to  make  them,  and  should  be  scru- 
pulously observed  by  both  parties  to  the 
contract. 

2.  That  in  so  far  as  the  charter  and 
franchise  are  silent,  public  utility  busi- 
ness should  stand  on  the  same  basis  as 
other  business  of  equal  risk  and  magni- 
tude, being  subject  to  governmental  re- 
pression when  it  is  unfair  or  oppressive 
in  its  dealings  with  the  public,  and  free 


- 


PREFACE  xi 

interference  so  long  as  its  dealings 
e  fair  and  just. 

3.  That  fairness  and  even  justice 
should  characterize  all  the  acts  of  utility 
owners  and  public,  growing  out  of  their 
mutual  relationships. 

For  valuable  suggestions  the  author  is 
indebted  to  his  colleagues,  Professor  P.  S. 
Pierce  of  the  Department  of  Economics 
d  Sociology,  Professor  J.  B.  Hill  of  the 
epartment  of  Electrical  Engineering, 
d  Professor  S.  M.  Woodward  of  the 
partment  of  Mechanics  and  Hydrau- 
but  it  is  not  intended  by  this  ac- 
knowledgment to  imply  that  they  or 
any  of  them  agree  with  all  of  the  ex- 
pressed conclusions  and  opinions. 


II 


WM.  G.  RAYMOND. 

>WA  CITY,  IOWA, 
August,  1917. 


CONTENTS 


I.    GENERAL  RELATIONSHIPS 
SUITABLE  CONTROL  - 
RATE  CONTROL 
WHAT  is  FAIR  RETURN   - 
V.    VALUATION       - 
AFTERWORD       - 


PAOB 

vii 

1 

-  26 

-  57 

-  87 

-  119 

-  172 


xiii 


HAT  IS  FAIR 


J  CHAPTER  I 

GENERAL  RELATIONSHIPS 
vTuvernment    and    the    Individual.  — 

Perhaps  it  is  trite  to  say  that  in  the  last 
analysis  government  exists  solely  for  the 
benefit  of  the  individuals  governed  —  all 
the  individuals;  but  even  if  it  is  trite,  it 
is  a  thought  that  must  be  constantly  in 
mind  when  discussing  individual  or  cor- 
porate relationship  with  government. 
Modern  government  must  be  of  the 
people,  and  it  must  be  for  the  people 
governed,  but  it  can  be  only  indirectly  by 
the  people. 

The  simplest  and  natural  form  of  gov- 
ernment is  the  parental  government  of 
the  family.  When  this  is  efficient  and 
wise,  it  protects  the  members  of  the  fam- 
ily from  wrongs  attempted  to  be  perpe- 


2  WHAT  IS  FAIR 


trated  by  other  families  or  individuals;  it 
protects  the  family  property  from  out- 
side interference;  and  it  so  administers 
its  internal  affairs  as  to  protect  each 
member  from  the  selfishness  and  greed 
or  unruly  passion  of  every  other  member. 
It  performs  other  functions  that  need  not 
be  mentioned  now. 

So  government  of  the  people  must  pro- 
tect every  individual  in  the  enjoyment 
of  his  inalienable  rights  of  life,  liberty, 
and  the  pursuit  of  happiness,  and  thus 
must  protect  him,  so  far  as  possible, 
from  interference  from  outside  the  body 
of  people  forming  the  government,  and 
from  the  selfishness  and  greed  and  unruly 
passion  of  every  other  individual  of  his 
own  group.  It  must  sometimes  protect 
him  from  himself. 

Government  may  also  do  for  the  indi- 
vidual what  he  cannot  so  economically 
or  completely  do  for  himself,  and  may 
undertake  any  line  of  activity  that  the 
people  wish  to  undertake.  It  may  lay 
out  and  build  roads  and  streets  for  the 
individual  to  travel  over;  it  may  operate 


GENERAL  RELATIONSHIPS  3 

vehicles  over  the  roads  and  streets  to 
carry  the  goods  and  person  of  the  indi- 
vidual; it  may  build  and  operate  other 
ways  for  carrying  the  goods  of  the  indi- 
vidual and  the  individual  himself;  it  may 
create  and  operate  works  for  supplying 
necessaries,  and  even  luxuries  of  life  to 
the  individual;  it  may  till  the  soil;  raise 
and  slaughter  animals  and  manufacture 
and  supply  animal  and  vegetable  food; 
manufacture  and  supply  clothing  and 
other  articles  necessary  or  disirable; 
indeed,  there  is  no  form  of  human 
activity  in  which  government  may  not 
engage  if  the  people  governed  wish  to 
live  as  a  community  with  common  prop- 
erty operated  and  administered  by  chosen 
representatives. 

Because  most  men  possess  ambition  to 
be  independent,  to  live  their  individual 
lives  in  their  own  way,  to  reap  for  them- 
selves and  their  progeny  the  results  of 
their  own  labor  and  intelligence,  the  com- 
munity idea  has  not  been  adopted  gener- 
ally. In  the  past  leading  spirits  gathered 
following  clans;  some  of  these  developed 


4  WHAT  IS  FAIR 

into  monarchies  and  empires;  and  finally 
came  limited  monarchies  and  republics. 

Under  modern  government  the  indi- 
vidual is  not  a  lease  holder  of  the  sov- 
ereign. He  may  own  the  fee  to  his  land 
and  other  property;  and  so  long  as  he 
obeys  the  laws  that  he,  himself,  has  es- 
tablished through  his  representatives,  he 
may  work  as  he  pleases  and  may  enjoy 
as  his  own  the  products  of  his  labor,  or 
the  results  of  his  intelligence  and  fore- 
sight. He  must  pay  his  allotted  propor- 
tion of  the  expense  for  the  conduct  of  his 
government,  which  he  does  in  various 
ways  but  mostly  by  paying  direct  or  in- 
direct taxes. 

Government  may  take  the  property  of 
the  individual  when  it  is  deemed  neces- 
sary for  the  public  good,  the  good  of  all 
or  many  individuals,  but  under  American 
government  it  may  not  do  so  without 
due  process  of  law,  which  includes  paying 
for  the  property  taken  what  it  is  reason- 
ably worth  together  with  the  amount  of 
any  damages  to  remaining  property  due 
to  the  taking.  To  determine  what  prop- 


GENERAL  RELATIONSHIPS  5 

erty  is  reasonably  worth  and  the  amount 
of  damage  to  remaining  property,  may 
be  and  frequently  is  quite  difficult. 
When  government  takes  private  prop- 
erty —  that  of  an  individual  or  a  corpo- 
ration —  for  public  use,  it  is  said  to 
exercise  its  right  of  eminent  domain. 

Likewise  government  may  exercise  a 
proper  supervision  over  the  conduct  of 
business  to  see  that  it  is  devoid  of  fraud- 
ulent or  immoral  practice,  or  practices 
calculated  to  be  excessively  burdensome 
on  the  weaker  and  more  ignorant  of  the 
people;  and  to  supervise  in  certain  other 
directions  that  will  be  discussed  later. 

A  corporation  is  an  artificial  individual, 
which  within  the  limits  of  its  privileges 
does  business  just  as  a  natural  individual 
does.  A  corporation  is  created  by  the 
issuance  by  government  of  a  charter  or  a 
certificate  of  incorporation  to  a  person  or 
persons,  which  charter  or  certificate  per- 
mits the  holders  to  act  as  representatives 
of  a  newly  created  intangible  entity  and 
limits  their  activities  to  certain  lines  spe- 
cifically stated  in  the  charter  or  articles 


6  WHAT  IS  FAIR 

of  incorporation,  and  defines  and  limits 
also  their  responsibilities.  When  those 
permitted  lines  of  activity  involve  the 
acquiring  of  property,  and  its  use,  then, 
subject  to  the  limitations  of  the  charter, 
the  rights  of  the  corporation  with  respect 
to  such  property  are  the  same  as  would 
be  those  of  an  individual  who  might  own 
it.  Those  individuals  who  own  stock  of 
the  corporation  are  sometimes  personally 
responsible  to  some  extent  for  the  acts  of 
the  corporation  and  sometimes  not  at  all, 
according  to  the  character  of  the  corpo- 
ration and  the  laws  under  which  it  is 
formed.  The  natural  individual  exists  by 
act  of  nature  and  is  a  free  moral  agent 
doing  as  he  pleases  so  long  as  he  keeps 
within  the  laws  of  the  country  in  which 
he  lives  and  obeys  the  laws  of  nature. 
If  he  is  a  citizen  of  a  republic,  the  laws 
he  must  obey  are  those  established  by 
his  own  representatives  in  government. 
The  corporation  —  an  artificial  individual 
-  exists  by  permission  of  government 
and  is  subject  not  only  to  all  the  statute 
and  common  laws  governing  the  indi- 


GENERAL  RELATIONSHIPS  7 

vidual  but  to  certain  other  specific  laws 
limiting  its  activities  and  governing  its 
procedure,  which  it  is  conceded  govern- 
ment has  the  right  to  impose  for  the  good 
of  the  public  on  any  creature  of  its  own 
creation,  even  as  nature  imposes  certain 
laws  on  the  objects  of  her  creation  and 
punishes  the  individual  violating  them. 
And  every  corporation  by  seeking  and 
accepting  its  charter  or  certificate  ac- 
knowledges this  right  of  governmental 
control. 

Property  and  Ownership  Rights.  - 
Property  is  anything  that  may  be  owned 
by  a  person.  It  may  be  a  tangible  thing 
or  it  may  be  an  intangible  right.  Thus 
one  may  own  a  piece  of  land;  the  land  is 
property;  another  may  own  the  right  to 
cross  this  land  at  a  certain  place;  this 
right  is  property;  it  may  and  probably 
does  also  belong  to  the  owner  of  the  land 
but  he  owns  the  land  subject  to  the  right 
of  his  neighbor  to  cross  it  at  the  particu- 
lar place.  Such  a  right  is  called  an  ease- 
ment. Generally  an  easement  is  what 
the  public  owns  when  it  takes  the  prop- 


8  WHAT  IS  FAIR 

erty  of  an  individual  for  a  road.  Should 
the  road  ever  be  closed  the  ownership  of 
the  right  to  use  the  ground  exclusively 
should  revert  to  the  owner  of  the  ad- 
joining land.  If  government  buys  a 
piece  of  land  for  public  use  outright  - 
buys  the  fee  as  the  saying  is  —  govern- 
ment becomes  the  owner  of  the  land  and 
there  is  no  reversion  when  the  public  is 
through  using  the  land  for  the  purpose 
for  which  it  was  acquired.  Government 
may  sell  the  land  and  devote  the  money 
received  to  other  lawful  purposes  or  it 
may  use  the  land  for  any  lawful  purpose; 
it  owns  the  physical  thing  not  simply  the 
intangible  right  to  use.  Of  course,  land 
not  being  wholly  movable,  cannot  be 
handled  as  some  other  property,  and  in 
general,  excepting  mining  properties, 
practically  only  the  free  use  of  the  land 
is  bought  and  sold  or  owned. 

So  when  a  railroad  company  is  char- 
tered, government  exercises  its  own  right 
of  eminent  domain  on  behalf  of  the  rail- 
road and  permits  condemnation  proceed- 
ings to  be  instituted  whereby  the  rail- 


GENERAL  RELATIONSHIPS  9 

road  company  takes  the  land  that  it 
needs  for  its  purposes  from  private  own- 
ers, obtaining  only  an  easement,  the 
property  taken  reverting  to  the  adjoin- 
ing owners  when,  if  ever,  the  railroad 
company  or  its  successor  ceases  to  use 
the  land  for  railroad  purposes.  But  the 
railroad  company  may  buy  outright  from 
its  owners,  purchasing  the  fee  and  not  an 
easement  and  when  it  does  this  the  land 
so  purchased  may  be  used  for  any  pur- 
pose within  the  chartered  activities  of 
the  company,  or  it  may  be  sold  as  any 
other  property  wholly  owned.  The  rail- 
road company  may  sell  its  whole  prop- 
erty, including  the  easements,  to  others. 
Generally  railroad  companies  try  to  agree 
as  to  price  with  owners  of  lands  needed 
for  the  construction  of  the  railroad  and 
try  to  buy  the  fee.  When  unable  to  do 
so  they  invoke  government  aid  to  take 
the  land  for  them,  which  government 
does  but  secures  for  them  only  an  ease- 
ment for  railroad  purposes.  One  rail- 
road company  may  purchase  the  right  to 
operate  its  trains  over  the  roadway  of 


10  WHAT  IS  FAIR 

another  company.     This  right  is  prop- 
erty and  presumably  has  value. 

If  government  builds  its  own  water- 
works, it  may  condemn  and  take  the  nec- 
essary property  from  its  private  owners, 
but  if  government  gives  an  individual  or 
corporation  a  franchise  to  serve  the  pub- 
lic with  water,  government  as  a  rule 
does  not  exercise  its  right  of  eminent 
domain  on  behalf  of  the  individual  or 
corporation  which  is  compelled  to  buy 
such  private  property  as  it  needs.  In 
certain  states  government  will  exercise 
its  right  of  eminent  domain  in  behalf  of 
an  electric  lighting  company  having  a 
contract  to  light  a  city  or  town  and  de- 
siring to  possess  a  certain  water  power 
or  lands  adjacent  to  such  power  for  its 
use,  but  in  general  government  exercises 
its  right  of  eminent  domain  for  privately 
owned  public  utilities  only  when,  as  is  the 
case  with  companies  owning  railroads, 
telegraph,  telephone,  or  power  trans- 
mission lines,  they  must  of  necessity 
use  particular  properties  or  pieces  of 
property  in  order  to  exist  at  all  for  the 


GENERAL  RELATIONSHIPS  11 

service  of  the  public.  Thus  the  railroad 
must  pass  over  the  land  between  its 
termini;  its  route  may  be  slightly  varied 
to  be  sure,  but  only  within  limits  and  still 
be  at  all  feasible;  therefore  if  public 
necessity  requires  the  railroad,  as  must 
be  supposed  when  the  public  gives  the 
company  its  charter,  government  must 
see  to  it  that  the  company  is  able  to 
secure  the  right  to  build  and  operate 
along  a  feasible  and  economical  route. 
On  the  other  hand  the  electric  lighting 
company  needs  only  the  public  streets 
or  its  lines  and  in  general  is  able  to 
locate  its  power  house  at  almost  any 
point  that  is  reasonably  convenient,  and 
hence  may  buy  in  the  open  market  and 
does  not  need  the  exercise  of  the  right  of 
eminent  domain,  which  should  be  en- 
forced only  when  absolutely  necessary. 

The  charter  that  the  railroad  secures 
permitting  it  to  build  and  operate  a  road 
for  hire  is  property;  the  franchise  that  a 
street  railway  or  electric  lighting  com- 
pany secures  from  a  city,  permitting  it 
to  occupy  the  streets  with  its  lines  and 


12  WHAT  IS  FAIR 

to  operate  these  lines  for  hire,  and  pre- 
sumably at  a  profit,  is  property.  Char- 
ters and  franchises  may  be  bought  and 
sold. 

When  government  grants  a  charter  or 
franchise  to  an  individual  or  company, 
permitting  the  creation  and  operation  of 
a  plant  for  the  performance  of  a  public 
service  for  hire,  the  charter  or  franchise 
should  definitely  set  forth  what  privi- 
leges are  granted,  what  restrictions  are 
imposed,  and  what  degree  of  control 
government  may  exercise.  Unfortu- 
nately charters  and  franchises  of  the  past, 
and  indeed  many  carelessly  drawn  char- 
ters and  franchises  of  the  present  are 
wanting  in  complete,  definite,  or  ade- 
quate statements,  and  as  a  result  many 
troublesome  questions  have  arisen  be- 
tween government  and  public  utility 
companies.  Corporations  have  failed  to 
render  the  character  or  quantity  of  service 
demanded  by  the  public  and  sometimes 
provided  for  in  the  franchise,  though 
often  only  by  implication  or  inadequate 
expression,  and  government  has  sought 


GENERAL  RELATIONSHIPS  13 

to  exercise  a  control  not  specifically  men- 
tioned in  the  charter  or  franchise,  under 
the  general  notion  that  all  persons  or 
companies  engaged  in  public  service  are 
subject  to  proper  governmental  control 
in  any  direction,  and  to  any  degree  that 
from  time  to  time  seems  necessary  in  the 
interest  of  the  public  good.  And  just  as 
some  corporations  have  failed  in  their 
plain  duty  to  the  public  served,  so  have 
public  officers  and  would-be  public  offi- 
cers sought  favor  with  the  public  by  ad- 
vocating closer  regulation  or  control  of 
and  lower  rates  for  service  by  the  utility 
companies.  There  have  been  and  are 
some  good  utility  corporations  and  some 
good  public  officers;  and  there  have  been 
and  are  some  bad  utility  corporations  and 
some  bad  public  officers. 

The  attitude  of  the  courts  is  very  well 
expressed  in  a  few  sentences  from  Judge 
Sessions7  opinion  in  the  Ann  Arbor  Rail- 
road Rate  Case: 1 

1  Ann  Arbor  Railroad  Company  vs.  Cassius  L.  Glas- 
oow  et  al,  U.  S.  District  Court  for  the  Eastern  District 
of  Michigan.  March,  1916. 


14  WHAT  IS  FAIR 

"  The  properties  of  railroad  companies 
and  oth«r  public  utility  corporations  are 
devoted  tb  public  use  and,  therefore,  are 
necessarily  subject  to  public  regulation 
within  constitutional  limitations.  Such 
corporations  are  clothed  with  unusual 
powers  and  owe  a  corresponding  duty  to 
exercise  those  powers  fairly  and  reason- 
ably and  for  the  public  good.  Every 
charter  or  franchise  granted  to  such  a 
corporation  contains  a  direct  obligation 
to  yield  obedience  to  the  lawful  man- 
dates of  the  sovereignty  to  which  it  owes 
its  existence.  Railroad  property  is  so  far 
public  in  its  nature  as  to  be  subject  at 
all  times  to  reasonable  legislative  regu- 
lation and,  on  the  other  hand,  is  so  far 
private  in  character  that  its  owners  can- 
not be  deprived  of  any  part  thereof 
without  just  compensation.  On  one  side 
is  the  imperative  duty  to  render  required 
service  at  a  reasonable  rate  and  upon 
the  other  side  is  the  absolute  right  to  be 
permitted  to  earn  a  fair  return  upon  the 
capital  necessarily  invested  in  the  enter- 
prise." 


GENERAL  RELATIONSHIPS  15 

The  usual  expression  is  "  fair  return  " 
on  the  "  fair  value  "  inst  of  on  the 
"  capital  invested."  "  Fair-return  "  and 
"  fair  value  "  are  discussed  in  Subsequent 
chapters. 

When  government  has  permitted  a 
company  to  create  a  plant  to  perform 
public  service  and  to  perform  that  service 
for  hire  without  restriction  as  to  rates, 
and  the  company  proceeds  to  take  ad- 
vantage of  its  rights  and  builds  up  a 
business  yielding  it  a  large  return,  the 
right  to  continue  to  operate  and  to  earn 
until  the  expiration  of  the  time  limit  of 
the  franchise,  is  conceived  to  be  property 
just  as  much  as  the  land  or  physical  plant 
owned  by  the  company,  none  of  which 
the  public  should  be  able  to  take  away 
without  proper  compensation.  What  may 
be  considered  proper  compensation  and 
the  general  principles  underlying  its  de- 
termination is  treated  in  the  chapter  on 
Value.  The  point  to  be  emphasized  here 
is  that  whatever  the  corporation,  or  the 
individual,  if  it  be  an  individual  that  owns 
the  franchise,  owns,  whether  physical  or 


16  WHAT  IS  FAIR 

intangible,  whether  land,  plant,  or  rights, 
is  to  be  considered  as  property  which 
not  even  government  may  take  either  in 
whole  or  in  part  so  long  as  it  is  lawfully 
held  and  used,  without  due  process  of 
law,  which  includes  fair  compensation  for 
whatever  is  taken,  and  the  amount  of  any 
damage  that  may  accrue  to  the  remain- 
ing property  by  reason  of  the  taking. 
There  are  those  who  question  the  right  of 
a  company  owner  to  continue  to  earn  at 
any  acquired  rate,  if  that  rate  is  judged 
to  be  excessive  by  a  competent  public 
authority;  holding  that  the  right  to  es- 
tablished earning  rate  is  not  property 
with  value.  Arguments  may  be  made  to 
establish  the  soundness  of  this  position 
and  others  to  establish  its  fallacy;  but  it 
is  difficult  to  conceive  of  any  conclusive 
argument  either  way,  and  the  thought  is 
advanced  that  the  soundness  or  unsound- 
ness  of  the  position  taken  must  be  deter- 
mined finally  by  appeal  to  man's  inherent 
sense  of  justice.  Some  considerations 
that  perhaps  will  guide  that  sense  will 
be  found  in  the  following  article. 


GENERAL  RELATIONSHIPS  17 

Profits  Earned.  -  -  The  right  to  earn  a 
profit  over  and  above  expenses  is  con- 
ceded to  all  men  in  private  business. 
To  the  private  business  man  the  public 
concedes  the  right  to  include  a  salary 
for  himself  in  his  operating  expense  and 
when  he  does  so  he  gets  a  living  out  of 
the  expense  of  his  business  and  his  profit 
may  be  saved  and  accumulated  from 
year  to  year  until  he  has  secured  a  com- 
petence or  a  large  fortune.  He  is  rated 
as  a  successful  man  if  he  accumulates  a 
competence,  as  a  particularly  successful 
man  if  he  accumulates  a  large  fortune, 
and  so  long  as  his  acts  are  considered 
honorable  he  is  praised  for  his  intelli- 
gence and  business  ability  and  his  advice 
may  be  sought  on  public  matters.  There 
is  no  limit  set  to  his  rate  of  profit  or  the 
magnitude  of  his  operations.  Except 
rarely  ,in  times  of  greatest  stress,  as  a 
time  of  war,  the  law  will  not  attempt  to 
regulate  his  earnings,  nor  even  then  un- 
less he  be  judged  to  be  oppressing  the 
people,  and  to  reduce  his  already  ac- 
quired earning  capacity  would  be  to  take 


18  WHAT  IS  FAIR 

his  property  without  just  compensation, 
which  is  a  violation  of  the  court's  inter- 
pretations of  the  constitution  of  this 
country.  This  is  said  with  full  knowl- 
edge of  the  decision  of  the  U.  S.  Supreme 
Court  in  the  Oregon  "  Hours  of  Labor  " 
Case  1  which  simply  sustained  a  police 
regulation,  established  as  was  distinctly 
stated  in  the  act,  in  the  interest  of  the 
health  of  the  community.  It  is  recog- 
nized that  police  regulations  may  be 
established  in  the  interest  of  the  common 
good  that  seem  to  limit  individual  activi- 
ties and  that  may  be  construed  by  some 
to  be  depriving  the  individual  of  prop- 
erty —  the  right  to  work  as  he  will  - 
without  just  compensation.  The  indi- 
vidual may  work  as  he  will  so  long  as  he 
does  not  make  a  nuisance  of  himself  and 
does  not  interfere  with  the  welfare  of 
the  community.  The  right  to  work  in 
such  ways  as  to  create  a  nuisance  or  in- 
terfere with  the  welfare  of  the  commu- 
nity is  not  property;  there  is  no  such 

1  Bunting  vs.  The  State  of  Oregon.    Decided  April 
9,  1917. 


GENERAL  RELATIONSHIPS  19 

right  pertaining  to  any  individual  of  the 
United  States  government,  which  was 
established  to  "  promote  the  general  wel- 
fare. "  Hence  to  prevent  the  individual 
by  law  from  creating  a  nuisance,  or  in- 
terfering with  the  general  welfare,  is  not 
taking  his  property.  Governing  the  use 
of  property  and  taking  property  are  two 
different  things,  which  should  be  clearly 
distinguished  but  are  sometimes  con- 
fused. If  earning  large  profits  is  deter- 
mined to  interfere  with  the  general  welfare 
of  the  community  then  large  profits  must 
be  prohibited,  but  this  prohibition  should 
apply  to  purely  private  enterprises,  if 
there  are  any  such,  as  well  as  to  privately 
owned  public  utilities. 

The  unfair  and  altogether  reprehen- 
sible business  methods  of  certain  private 
corporations  and  monopolies  are  known, 
but  are  not  now  being  considered.  Only 
operations  under  fair  and  honorable  busi- 
ness methods  are  being  discussed  for  pur- 
poses of  comparison.  Formerly  to  cor- 
porations proposing  to  perform  public 
service,  franchises  and  charters  were  given 


20  WHAT  IS     FAIR 

without  any  provision  for  the  limiting  of 
profits  or  for  the  public  control  of  the 
rates  for  the  service.  Under  these  char- 
ters or  franchises  corporations  built 
plants  for  public  service,  fixed  their  own 
charges,  and  in  many  cases  became  very 
profitable  concerns;  so  much  so  that 
their  stocks  gradually  advanced  until 
they  were  worth  several  times  their  nor- 
mal par  value.  Later  franchises  gave 
the  public  the  right  to  revise  or  approve 
rates  from  time  to  time  and  to  regulate 
the  operations  of  the  corporations  in 
other  ways. 

Gradually  public  opinion  as  voiced  by 
the  courts  seems  to  have  concluded  that 
all  privately  owned  public  utility  prop- 
erties, even  though  operating  under  char- 
ters which  are  silent  on  the  questions  of 
rates,  earnings,  and  profits,  are  entitled 
to  earn  only  a  fair  return  on  the  fair  value 
of  the  property  used  in  the  public  service, 
but  there  has  been  no  determination  of 
what  constitutes  a  fair  rate  of  return,  nor 
any  universally  adopted  method  of  de- 
termining the  fair  value  upon  which  the 


GENERAL  RELATIONSHIPS  21 

fair  return  is  to  be  computed.  Public 
opinion  as  voiced  by  the  courts  will  even- 
tually control  these  matters  and  it  seems 
essential  to  fair  dealing  that  public  opin- 
ion should  be  fair  and  reasonable.  It 
may  be  argued,  as  stated  in  Judge  Ses- 
sions' opinion  already  quoted,  that  no 
corporation  has  ever  been  formed  that 
was  not  under  obligation  to  recognize  the 
supreme  authority  of  the  government 
that  created  it,  and  its  own  amenability 
to  laws  enacted  subsequent  to  its  estab- 
lishment. 

Laws  change  with  the  advance  of  civili- 
zation and  the  change  in  living  conditions. 
New  laws  are  found  necessary  to  govern 
the  conduct  of  individuals  under  new  con- 
ditions or  unforeseen  and  consequently 
unprovided  for  practices  detrimental  to 
public  welfare.  The  introduction  of 
many  conveniences,  the  telegraph,  the 
telephone,  the  automobile,  the  jitney 
bus,  or,  on  the  other  hand,  the  develop- 
ment of  new  methods  of  defrauding  bank 
depositors  or  corporation  stockholders,  or 
of  oppressing  or  defrauding  the  public, 


22  WHAT  IS  FAIR 

all  have  required  new  laws  or  modifica- 
tions of  old  ones  to  meet  the  changed 
conditions  and  for  the  protection  of  the 
public.  But  it  is  at  least  doubtful  if  fair 
dealing  will  permit  laws  to  be  enacted 
subsequent  to  the  chartering  of  a  corpo- 
ration, or  if  enacted,  to  be  enforced,  to 
materially  alter  the  conditions  of  the 
charter  or  franchise,  which  is  essentially 
a  contract,  or  to  destroy  any  part  of  the 
property  lawfully  created  under  the  char- 
ter. If,  by  lawful  methods,  honorable 
and  without  unfair  discrimination,  a  pub- 
lic utility  corporation  has  under  the  pub- 
lic eye  built  up  a  business  having  a  de- 
pendable net  return  of  any  amount  or 
any  rate  upon  its  actual  cash  investment, 
the  right  to  earn  that  return,  or  so  much 
of  it  as  may  be  possible  during  the  life  of 
the  franchise,  would  seem  to  be  lawfully 
acquired  property,  only  to  be  taken  from 
the  corporation  for  public  use  by  the  ex- 
ercise of  the  supreme  power  of  govern- 
ment and  upon  proper  payment  of  just 
compensation.  Private  dependable  net 
earnings  would  be  so  considered;  why 


GENERAL  RELATIONSHIPS  23 

not  honorably  and  fairly  developed  earn- 
ings   of    the    corporation? 

Dependable  earning  capacity  is  an  ele- 
ment on  which  the  value  of  the  property 
depends,  and  as  it  is  distinct  and  sepa- 
rate from  the  physical  property,  it  must  be 
judged  to  be  an  intangible  element  of  prop- 
erty going  with  the  physical  property  as 
a  right,  and,  being  otherwise  dependable, 
subject  to  destruction  only  by  public  act. 
If  the  public  concludes  that  the  earnings 
are  too  high  it  may  through  its  legisla- 
tive bodies  reduce  those  earnings  to,  but 
not  below,  what  is  judged  to  be  a  fair 
return,  by  reducing  the  rates  charged  for 
service,  and  this  would  be  fair  if  the  char- 
ter recognizes  the  right  by  definite  pro- 
visions fixing  a  limit  to  earnings;  but 
unless  this  right  has  been  reserved  in  the 
charter,  so  that  the  corporation  has  had 
due  notice  of  the  possibility  and  the  earn- 
ings exceed  the  charter  limit,  it  is  at 
least  doubtful  to  a  layman  if  the  public 
is  acting  under  the  constitution  if  it  thus 
destroys  a  part  of  the  created  property  of 
the  corporation,  if  the  acquired  ability 


24  WHAT  IS  FAIR 

to  earn  is  property,  without  due  compen- 
sation. The  might  of  public  opinion, 
which  will  eventually  be  voiced  by  the 
courts,  may  accomplish  such  a  result  but 
will  not  fair  dealing  be  outraged  in  the 
accomplishment?  It  may  be  fair  at  any 
time  to  limit  the  future  returns  of  the 
corporation  to  any  fair  sum  not  less  than 
that  enjoyed  at  the  time  of  consideration, 
or  to  limit  the  returns  on  future  invested 
capital  to  a  less  rate  of  return  than  that 
enjoyed  by  the  already  invested  capital, 
so  long  as  the  limited  rate  is  a  fair  rate. 
This  matter  is  further  discussed  in  the 
chapters  on  FAIR  RETURN  AND  VALUA- 
TION. 

It  is  not  proposed  to  defend  any  cor- 
poration which  has  violated  its  charter 
or  franchise  privileges  or  obligations  or 
has  otherwise  improperly  oppressed  a 
helpless  public.  Such  corporations  should 
be  dealt  with  according  to  law  and  to 
their  deserts.  But  it  is  intended  to  de- 
clare that  earning  large  profits  is  not  per 
se  a  crime  or  misdemeanor;  that  except 
as  it  must  be  governed  by  the  terms  of  its 


GENERAL  RELATIONSHIPS  25 

agreement  with  the  public,  a  public  util- 
ity corporation  should  stand  on  the  same 
footing  as  any  private  business  catering 
to  or  depending  on  the  public  for  sup- 
port. The  fact  that  it  is  a  creature  of 
government,  is  possibly  a  partial  or  com- 
plete monopoly,  has  possibly  been  fav- 
ored by  government  in  some  way,  and 
hence  is  amenable  to  government  in  cer- 
tain matters,  should  all  be  reflected  in 
the  charter  —  a  contract  —  the  letter  and 
spirit  of  which  both  corporation  and  gov- 
ernment should  observe  in  the  perform- 
ance of  their  respective  parts. 


CHAPTER  II 
SUITABLE  PUBLIC   CONTROL 

Directions  of  Control.  —  It  is  now 
generally  conceded  in  America  that  the 
public  may  exercise  suitable  control  over 
all  public  utility  companies  or  owners. 
What  constitutes  suitable  control  in  times 
of  peace  and  ordinary  business  activity 
becomes  a  pertinent  and  sometimes  a 
troublesome  question. 

With  respect  to  modern  corporations 
chartered  in  the  light  of  present  public 
opinion,  the  charter  should  indicate  defi- 
nitely what  directions  public  control  may 
take  —  the  character  of  the  control  will 
depend  on  the  characteristics  of  the  sev- 
eral controlling  authorities.  But  many 
charters  —  even  modern  ones  —  are  quite 
defective  in  this  respect  and  the  older 
ones  are  apt  to  be  quite  silent  as  to  any 
details  of  public  control.  Just  the  ex- 
tent then  of  public  control  that  is  suit- 

26 


SUITABLE  PUBLIC  CONTROL  27 

able  or  proper  in  a  given  case  may  de- 
pend on  the  terms  of  the  charter  or 
franchise.  The  principal  directions  in 
which  the  public  should  undertake  to 
exercise  control  are: 

1.  Capitalization.  -  -  To   see   that   au- 
thorized evidences  of  debt  —  stocks  and 
bonds  —  are  not  issued  in  excess  of  the 
value   of  the  property  or   the  sacrifice 
made  by  the  company  in  money,  or  the 
money  equivalent  of  the  value  of  service 
or   material   furnished    in    creating   the 
property. 

2.  Character  of  Operations.  -  -  To   see 
that  they  are  within  the  charter  provi- 
sions. 

3.  Safety  of  Operations.  -  -  To  see  that 
the   conduct   of    the   business    proceeds 
with  as  much  safety  as  possible  to  em- 
ployes, patrons,  and  public. 

4.  Equity  in  Service.  -  -  To   see   that 
equity  is  observed  in  dealing  with  pat- 
rons;   that  service  offered  one  patron  is 
not  withheld  from  another  operating  un- 
der like  conditions;    that  no  favoritism 
is  shown. 


28  WHAT  IS  FAIR 

5.  Quality  of  Service.  —  To   see  that 
the  service  rendered  the  public  conforms 
with  that  prescribed  in  the  charter  or 
franchise. 

6.  Control  of  Rates  for  Service.  —  To 
see  that  they  are  sufficient  but  neither 
exorbitant  nor  improperly  discriminatory. 

A  few  of  the  principal  considerations 
leading  to  these  conclusions  will  be  given, 
control  of  rates  being  treated  in  a  chap- 
ter by  itself.  Municipal  utilities  should 
be  under  state  control.  Excepting  with 
respect  to  certain  police  regulations  gen- 
eral control  of  interstate  utilities  should 
lie  with  the  federal  government. 

i.  Capitalization. -- The  private  busi- 
ness of  banking  is  recognized  by  common 
consent  to  be  a  business  of  such  vital 
importance  to  commercial  and  financial 
stability  as  to  warrant  the  exercise  of 
governmental  supervision  in  certain  mat- 
ters. One  of  these  matters  is  capitaliza- 
tion. The  banking  company  with  an 
authorized  capital  of  $100,000  issued 
must  have  $100,000  of  cash  or  its  equiva- 
lent actually  paid  in  to  the  company 


SUITABLE  PUBLIC  CONTROL  29 

treasury.  This  is  the  theory,  but  ways 
of  avoiding  a  complete  compliance  with 
the  law  are  sometimes  discovered  by 
smart  promoters. 

Industrial  enterprises  of  other  kinds 
are  not  always  so  guarded,  and  large  cap- 
ital issues  may  be  made,  representing 
very  little  actual  money  invested,  but 
representing  faith  in  a  future  prosperity 
or  earning  power.  Persons  will  invest  hi 
the  securities  of  such  industrial  enter- 
prises at  the  outset  as  a  speculation.  If 
the  faith  in  the  future  proves  well 
founded,  the  5  or  6  per  cent  return  on  a 
large  stock  issue  purchased  at  a  small 
price  may  represent  30  or  50  per  cent  or 
more  on  the  actual  investment.  There 
was  a  risk,  a  venture;  the  speculator 
played  to  win  and  won.  He  might  have 
lost,  but  if  he  had,  the  loss  would  not  be 
likely  to  interfere  with  the  general  prog- 
ress of  business  and  so  the  capitaliza- 
tion of  such  enterprises  has  not  been  in 
general  so  carefully  guarded  by  law  as 
has  the  capitalization  of  banks. 

The  element  of  chance  is  present  in  all 


30  WHAT  IS  FAIR 

business  to  some  degree,  and  is  an  im- 
pelling element  to  many  people.  The  line 
between  legitimate  chance  taking  and 
immoral  gambling  is  a  not  entirely  defi- 
nite line.  But  almost  certain  it  is  that 
it  would  be  undesirable  to  eliminate  en- 
tirely the  element  of  chance  from  gen- 
eral business.  If  no  one  had  taken  a 
chance  the  earth  would  not  be  yielding 
up  its  mineral  wealth  as  it  is  now  doing. 
If  no  one  had  taken  a  chance  much  of 
the  prairie  of  the  western  United  States, 
now  covered  with  growing  grain  or  feed- 
ing vast  herds  of  domestic  animals,  would 
still  be  in  virgin  grass,  supporting  only 
the  wild  herds  of  horses  and  bison.  In- 
deed, if  no  one  had  taken  a  chance, 
America  would  still  be  a  wilderness  in- 
habited only  by  wild  animals  and  wild 
men.  Farther  back  one  need  not  go. 

But  in  the  interest  of  general  stability 
it  is  considered  to  be  desirable  to  remove 
from  all  regular  business  as  much  of  the 
chance  element  as  may  be  called  "  gam- 
ble," and  to  leave  only  that  portion  that 
may  depend  on  men's  judgment  and  acts 


SUITABLE  PUBLIC  CONTROL  31 

of  Nature  unusual  and  not  to  be  foreseen. 
Moreover,  it  would  seem  to  be  desirable 
to  protect  the  innocent  and  unsophisti- 
cated individuals  of  the  family  from  those 
others  who  may  be  called  human  birds 
of  prey,  who  profit  and  grow  fat  at  the 
expense  of  those  whom  they  are  able  to 
defraud,  inducing  them  to  invest  their 
savings  in  worthless  stocks  or  bonds. 
To  a  large  extent  people  must  be  expected 
to  look  out  for  themselves;  government 
cannot  direct  all  the  actions  of  all  indi- 
viduals; cannot  keep  every  child's  feet 
out  of  the  mud  puddles.  But  there  are 
many  ways  in  which  within  the  law 
scheming  financial  operators  may  de- 
ceive and  defraud  the  public  generally, 
or  the  innocent  stock  and  bond  holders 
of  legitimate  enterprises.  To  safeguard 
the  public  and  investors  from  such  prac- 
tices should  be  a  part  of  the  duty  of  gov- 
ernment, and  one  of  the  ways  in  which 
it  may  proceed  is  to  see  that  in  all  incor- 
porated legitimate  real  enterprises  every 
dollar  of  capital  evidence  means  a  dollar 
put  into  the  property  that  is  capitalized, 


32  WHAT  IS  FAIR 

or  a  dollar  of  dependable  capitalized 
earning  capacity.  Capital  issued  or  in- 
vested cannot  always  represent  value, 
because  value  in  business  depends  on 
earning  capacity  and  a  new  venture  has 
always  a  problematic  earning  capacity. 
In  a  new  venture,  therefore,  capital  evi- 
dence, stocks,  and  bonds  should  repre- 
sent money  or  the  money  value  of  service 
and  materials  used  to  create  the  property; 
while  for  a  well-established  business  with 
good  proven  capacity,  capital  issues  may, 
if  permitted  in  certain  cases,  represent 
value  rather  than  money  spent. 

With  respect  to  this  element  of  control, 
government  or  public  is  not  more  inter- 
ested in  public  utility  corporations  than 
in  private  business  corporations,  except 
as  the  public  utility  corporation,  a  gov- 
ernmentally  created  monopoly,  may  use 
a  small  return  on  a  large  capital  issue  to 
justify  exorbitant  charges  for  service 
which  charges  yield  a  very  high  rate  of 
return  on  the  capital  actually  invested 
in  the  property  of  the  corporation.  The 
thing  that  makes  one  business  of  more 


SUITABLE  PUBLIC  CONTROL  33 

concern  to  the  people  than  another  is 
the  degree  of  necessity  to  general  busi- 
ness, life,  and  comfort,  pertaining  to  the 
service  of  the  business.  The  charges  of 
a  monopoly  company  furnishing  water 
are  of  great  interest  to  the  people,  and 
should  rightly  be  as  low  as  may  be  to 
yield  just  a  fair  return  to  the  corporation 
for  its  service.  The  charges  of  a  compet- 
itive corporation  dealing  in  staples  of 
food  are  of  equal  concern  to  the  public, 
but  until  government  undertakes  the 
control  of  all  business,  there  can  be  little 
control  of  such  charges.  Corners,  com- 
binations, and  hoarding  by  food  specu- 
lators, and  gambling  in  futures  may  be 
regulated,  but  the  charges  of  straight 
competitive  businesses  free  from  the  in- 
fluence of  combination  and  the  effect  of 
the  food  gambler's  activities,  will  always 
be  determined  by  the  law  of  supply  and 
demand.  The  fact  that  the  public  util- 
ity corporation  may  issue  securites  in 
excess  of  the  investment  and  thereby  de- 
ceive the  public  as  to  its  rate  of  return, 
together  with  the  fact  that  monopoly 


34  WHAT  IS  FAIR 

corporations,  performing  public  functions, 
should  deal  fairly  with  the  public  which 
created  them,  are  good  reasons  for  the 
control  of  the  capitalization  of  utility 
corporations,  even  though  there  were  no 
other  reasons  for  controlling  the  capital- 
ization of  all  corporations. 

It  is  advanced  as  sound  public  policy, 
that  capital  issues  of  all  corporations 
should  represent  either  money,  or  its 
value  equivalent,  invested,  or  value  as 
measured  by  dependable  earnings;  and 
that  for  the  purpose  of  avoiding  confu- 
sion when  discussing  rates  for  service  and 
fair  return,  public  utility  capital  issues 
should  represent  only  money,  or  its  value 
equivalent,  invested.  Old  corporations 
coming  under  active  control  for  the  first 
time  may  be  found  to  have  issued  secu- 
rities based  on  value  as  determined  by 
what  has  seemed  to  be  a  dependable 
earning  capacity.  It  is  not  proposed  to 
suggest  that  the  capital  of  these  corpo- 
rations be  changed,  although  this  would 
not  be  a  serious  matter,  if  the  total  earn- 
ings are  not  reduced.  It  has  been  a  not 


SUITABLE  PUBLIC  CONTROL  35 

uncommon  practice  to  build  utility  plants 
on  borrowed  capital,  the  bonds  sold  rep- 
resenting all  the  actual  money  put  into 
the  enterprise.  Issues  of  stock  have 
been  given  to  promoters  for  their  ser- 
vices, and  to  bond  purchasers  as  bonuses 
to  induce  them  to  lend  the  necessary 
money,  and  some  stock  has  been  sold  to 
secure  working  capital  and  for  cash  dis- 
tribution in  other  less  defensible  ways. 
The  stock  represents  the  speculative 
value  of  the  concern  and  the  promotion 
cost,  so  far  as  this  has  value  not  repre- 
sented by  cash  payments.  The  bonds 
represent  the  cost  of  the  physical  prop- 
erty. Sometimes  they  represent  more 
than  the  cost  of  the  physical  property  if 
sold  at  a  large  discount,  in  which  case 
some  part  of  the  bonds  represents  specu- 
lative value.  Speculative  value  when  it 
materializes  is  the  economist's  surplus 
value.  It  has  been  not  uncommon  in 
those  cases  in  which  the  state  chartering 
the  corporation  requires  a  statement  of 
cost,  to  so  manipulate  the  matter  through 
construction  organizations  within  the 


36  WHAT  IS  FAIR 

chartered  utility  corporation,  and  oper- 
ating companies  taking  the  property  over, 
as  to  be  able  to  report  the  property  as 
costing  the  equivalent  of  the  par  value  of 
the  entire  issue  of  bonds  and  stocks, 
which  may  be  issued  in  practically  equal 
amounts,  when  as  a  matter  of  fact  the 
cash  cost  of  the  physical  property  is  not 
more  than  the  par  value  of  the  bonds. 
The  remainder  represents  what  is  called, 
by  some  people,  water,  and  by  others, 
speculative  value,  and  by  others,  promo- 
tion cost,  and  by  economists,  surplus. 
There  are  instances  in  which  there  has 
been  no  bond  issue,  the  cost  of  the  whole 
property  being  met  with  money  raised  by 
the  sale  of  stocks. 

It  is  asserted  with  some  confidence 
that  the  sum  total  of  stocks  and  bonds 
issued  should  represent  no  more  than 
three  items,  namely:  The  money  reason- 
ably spent,  money  properly  held  as  work- 
ing capital,  and  the  reasonable  value  of 
promotion  service.  "  Reasonable  value 
of  promotion  service  "  is  subject  to  inter- 
pretation and  it  is  not  proposed  here  to 


SUITABLE  PUBLIC  CONTROL  37 

determine  what  this  should  be,  but  it  is 
asserted  again  with  some  confidence  that 
it  is  not  100  per  cent  or  approximately 
100  per  cent  of  the  cost  of  creating  the 
property.  There  can  be  no  harm  in  hav- 
ing two  classes  of  securites,  one  carrying 
a  fixed  interest  rate  to  be  paid  if  earned 
and  secured  by  a  mortgage  on  the  prop- 
erty and  called  either  bonds  or  preferred 
stock,  and  another  representing  the  spec- 
ulative value,  and  carrying  a  variable 
rate  of  return  depending  on  the  earnings, 
provided  it  is  clearly  understood  what 
each  class  stands  for.  If,  for  instance,  a 
property  costs  $1,000,000  total  when  put 
on  its  feet,  and  issues  5  per  cent  bonds 
in  the  sum  of  $1,000,000  sold  at  par 
(quite  unusual)  to  pay  the  cost,  and  issues 
$1,000,000  common  stock  to  represent 
ownership  of  the  business,  and  earns  10 
per  cent  on  that  stock,  it  must  not  be 
forgotten  that  the  property  is  paying  15 
per  cent  on  the  reasonable  investment, 
and  public  control  should  be  such  that 
these  things  are  known,  else  there  can 
be  no  proper  determination  of  fair  rate  of 


38  WHAT  IS  FAIR 

return  for  such  a  company.  In  this  case 
just  cited  the  profit  is  10  per  cent  on  the 
invested  capital  and  5  per  cent  is  the 
wage  of  the  money.  It  would  perhaps 
be  fairer  in  such  a  case  to  consider  the 
10  per  cent  not  as  a  profit  on  invested 
capital  but  the  wage  for  service,  or  profit 
on  the  business  over  and  above  expense, 
this  profit  for  convenience  being  spoken 
of  as  a  percentage  of  the  invested  capital. 
The  owners  who  earn  the  profit  may  have 
no  capital  at  all  in  the  business;  they 
have  borrowed  the  capital  and  pledged 
the  property  as  security;  if  they  fail  to 
earn  even  interest  on  the  bonds  they 
lose  nothing  but  their  time;  the  property 
is  transferred  to  the  bond  holders. 

In  such  a  case  as  the  foregoing  suc- 
cessful one,  it  would  be  more  logical,  as 
suggested,  to  speak  of  the  10  per  cent,  not 
as  profit  on  invested  capital  but  as  a  wage 
or  compensation  for  performing  the  serv- 
ice, which  wage  for  lack  of  a  better  unit  of 
measurement  is  measured  as  a  percentage 
of  the  invested  capital.  It  would  seem  to 
be  much  better  to  measure  the  profit  as 


SUITABLE  PUBLIC  CONTROL  39 

a  percentage  of  the  business  done,  if 
some  good  way  could  be  found  to  dis- 
courage the  high  cost  of  service  that 
would  be  likely  to  result  and  to  put  a 
premium  on  low  cost  of  service.  Ways 
have  been  tried  for  doing  this  but  not 
on  a  recognized  division  of  total  return 
into  interest  and  profit.  There  seems  to 
be  no  real  good  reason  why  a  regulation 
that  provides  for  a  greater  percentage  of 
profit,  or,  if  preferred,  a  greater  wage  for 
service,  as  a  reward  for  efficiency  shown 
in  reduced  cost  of  service  to  -consumers, 
should  prove  unsatisfactory  if  carefully 
worked  out  and  fairly  administered.  In- 
deed, it  is  thought  that  a  frank  recogni- 
tion of  the  division  of  total  earnings  into 
money  wage  (interest)  based  on  capital 
invested,  and  service  wage  or  compensa- 
tion, based  on  volume  of  business  done 
and  so  graduated  that  the  lower  the  cost 
to  the  consumer  the  higher  the  wage 
rate  and  total  compensation  to  the  serv- 
ing agent,  will  do  much  to  relieve  the 
tension  that  quite  generally  exists  be- 
tween the  public  and  its  service  corpora- 


40  WHAT  IS  FAIR 

tions.  This  suggestion,  thrown  in  here 
in  the  discussion  of  control  of  capitaliza- 
tion, will  be  elaborated  somewhat  else- 
where, and  is  thought  to  be  a  suggestion 
of  importance. 

Government  then  should  control  cap- 
italization of  public  utility  corporations 
in  order  to  protect  the  investing  pub- 
lic, and  to  simplify  the  work  of  rate 
regulation,  helping  to  make  it  fair  and 
thus  to  create  a  more  friendly  and  co- 
operative spirit  between  the  public  and 
its  service  companies. 

2.  Character  of  Operations.  —  Con- 
tracts made  by  a  corporation  beyond  the 
powers  conferred  by  its  charter  are  not 
enforceable  at  law.  The  charter  defines 
the  activities  of  the  corporation  and  it 
may  not  operate  beyond  its  stated  field. 
A  railroad  chartered  to  conduct  a  trans- 
portation business  only  may  not  engage 
in  coal  mining  as  a  business.  It  may 
own  and  operate  its  own  shops,  build  its 
own  cars  and  locomotives,  mine  its  own 
fuel,  and  in  general  engage  in  any  activi- 
ties that  it  may  deem  essential  or  desir- 


SUITABLE  PUBLIC  CONTROL          41 

able  activities  in  connection  with  the 
maintenance  of  its  transportation  busi- 
ness; but  it  may  not  build  cars  or  loco- 
motives for  sale,  mine  fuel  for  sale,  or  in 
general  engage  in  any  commercial  activ- 
ity except  the  manufacture  and  sale  of 
transportation. 

Nevertheless  corporations  have  not  in- 
frequently engaged  in  business  beyond 
their  legal  powers,  and  in  some  instances 
have  been  able  to  interfere  with  the  nor- 
mal conduct  of  business  by  favoring  the 
transportation  of  their  own  illegally  pro- 
duced commodity  as  against  similar  prod- 
ucts of  independent  operators.  Here  it 
is  not  necessary  to  introduce  public  policy 
as  a  reason  for  public  control.  Law  en- 
forcement is  all  that  is  necessary.  But 
public  policy  is  the  deciding  considera- 
tion when  discussing  the  question  "  Shall 
a  public  utility  corporation  be  given 
power  in  its  charter  to  engage  in  com- 
mercial enterprise  foreign  to  its  main 
purpose  and  in  competition  with  other 
individuals  or  corporations?  '  The  an- 
swer based  on  sound  public  policy  will  be, 


42  WHAT  IS  FAIR 

"  If  the  extra  activity  is  such  that  the 
normal  business  of  the  utility  corporation 
will  give  it  an  undue  advantage  over  the 
competitor  in  the  extra  activity,  the 
power  would  better  not  be  given."  And 
the  reason  is  simply  that  there  are  greedy 
members  of  the  family  who  regard  busi- 
ness as  war  in  which  every  advantage, 
fair  or  unfair,  is  to  be  taken  against  com- 
petitors —  other  members  of  the  family 
-and  government  exists  among  other 
purposes  to  protect  the  individual  from 
the  greed  and  unruly  passion  of  any  other 
individual,  and  particularly  is  this  true 
when  the  greedy  individual  is  govern- 
ment's own  creation. 

Unfortunate  has  been  the  experience 
of  some  corporations  engaging  in  wholly 
desirable  but  extra  charter  activities. 
The  Pullman  Company,  for  instance,  has 
been  estopped  from  performing  certain 
public  functions  for  the  town  of  Pull- 
man, which  it  created  with  altogether 
good  intent,  because  the  charter  of  the 
company  did  not  provide  for  these  activi- 
ties. Here  is  a  case  in  which  govern- 


SUITABLE  PUBLIC  CONTROL  43 

ment  might  well  include  within  the  char- 
ter of  the  corporation  the  right  to  do 
certain  things  apparently  foreign  to  the 
main  purpose  of  the  organization.  An 
electric  lighting  company  may  find  it  de- 
sirable in  order  to  protect  the  public  and 
develop  its  business  to  sell  fixtures  and 
wire  buildings.  Under  some  circum- 
stances this  may  be  proper. 

3.  Safety  of  Operations.  -  -  As  a  mat- 
ter of  moral  obligation  in  human  rela- 
tionships, any  business,  whether  public 
or  private,  should  be  carried  on  in  such  a 
manner  as  to  make  it  as  safe  as  possible 
for  those  engaged  in  the  business,  for 
those  served  by  the  business,  and  for  the 
public  at  large,  likely  in  any  way  to  be 
affected  by  the  conduct  of  the  business. 
Therefore  police  regulations  of  Boards  of 
Health,  Departments  of  Public  Safety, 
Departments  of  Labor,  or  Public  Utility 
Commissions  of  one  form  or  another  re- 
quire the  use  of  various  safety  appliances 
in  factories  and  industrial  plants  of  all 
kinds  for  the  protection  of  the  employes; 
in  and  on  hotels  and  boarding  houses, 


44  WHAT  IS  FAIR 

schoolhouses,  public  halls,  streets,  and 
places,  for  the  protection  of  the  using  pub- 
lic; and  they  require  safety  devices  to  be 
used  by  railroads  to  protect  the  employes 
and  the  traveling  public  and  those  who 
have  occasion  to  cross  railroad  proper- 
ties. Similar  regulations  provide  for  the 
proper  treatment  and  disposal  of  sewage 
and  wastes  of  all  kinds  so  that  they  shall 
not  become  nuisances,  or  endanger  the 
health  of  people  or  animals;  and  for  puri- 
fication of  water  supplies  to  make  them 
safe  for  common  use.  To  protect  the 
public  from  fraud  or  imposition  and  also 
as  health  measures,  regulations  may  pro- 
vide for  properly  labeling  all  articles  of 
food  or  drink  or  medicine,  manufactured 
and  offered  for  sale;  and  for  the  govern- 
mental inspection  of  food  preparations, 
packing  house  products,  etc.  In  fact 
government  assumes  to  itself  the  right  to 
protect  each  individual  of  its  family,  who 
may  be  unable  to  protect  himself,  from 
all  unnecessary  dangers  arising  through 
the  acts  of  other  individuals.  Regula- 
tions, then,  requiring  the  use  of  approved 


SUITABLE  PUBLIC  CONTROL  45 

safety  appliances,  methods  of  operation 
regarded  as  being  as  free  from  danger  as 
possible,  and  limiting  hours  of  continu- 
ous service  of  animals  and  human  beings, 
being  applied  to  all  industrial  enterprises 
as  required,  are  regarded  as  reasonable 
regulations  to  be  applied  to  public  utility 
properties,  and  hence  are  included  within 
the  conception  of  suitable  control. 

4.  Equity  in  Service.  -  -  It  is  believed 
to  be  right  simply  as  fair  conduct  be- 
tween men,  and  good  public  policy  as 
well,  for  every  business  enterprise  to 
treat  all  its  customers  alike  who  purchase 
service  or  supplies  under  essentially  simi- 
lar conditions,  and  it  is  asserted  that 
every  public  service  corporation  created 
by  government  to  serve  the  people  in 
the  place  of  government  is  in  duty  bound 
to  deal  thus  equitably  with  the  people. 
It  is  not  only  that  rates  for  service  must 
be  the  same  when  the  service  is  required 
under  like  conditions,  but  the  service 
should  be  the  same.  Railroad  corpora- 
tions should  not  withhold  cars  from  one 
customer,  nor  delay  them  in  transit 


46  WHAT  IS  FAIR 

\\  hile  furnishing  all  the  cars  that  are  asked 
by  another  favored  customer  and  forward- 
ing them  with  expedition.  Such  things 
have  been  done  and  businesses  have  been 
ruined  by  the  practice.  In  some  cases 
high  prices  due  to  an  artificially  created 
shortage  of  supplies  have  been  main- 
tained by  the  aid  of  railroads,  which  failed 
to  furnish  proper  car  service  to  relieve  the 
shortage.  Railroad  companies  should  not 
favor  one  locality  at  the  expense  of  an- 
other even  though  it  seems  advantageous 
at  the  moment  to  the  railroad  prop- 
erty. In  the  long  run  the  company  will 
find  it  of  advantage  to  build  up  industry 
all  along  its  line  rather  than  to  concen- 
trate certain  classes  of  industry  at  its 
terminals.  But  even  were  this  not  true, 
the  public  creature  of  service,  holding  its 
power  to  do  business  as  a  gift  of  the 
people,  must  treat  all  individuals  and  lo- 
calities with  fairness,  and  should  aid 
rather  than  obstruct  the  efforts  of  all  its 
customers  to  grow. 

Water  supply  companies  for  cities  have 
less  opportunity  to  deal  unfairly  with  cus- 


SUITABLE  PUBLIC  CONTROL  47 

tomers  than  have  transportation  com- 
panies. But  they  can  be  annoying  by 
furnishing  adequate  sized  services  to 
some  customers  and  services  too  small  to 
others.  Their  rates,  too,  may  be  inequi- 
table, but  this  will  be  considered  in  a  fol- 
lowing article. 

Electric  light  and  power  companies 
may,  if  they  choose,  greatly  annoy  and 
discourage  certain  customers  by  poor 
and  interrupted  service,  while  furnishing 
others  with  good  service.  A  power  com- 
pany supplying  power  to  a  lighting  com- 
pany, or  a  railway  company,  and  desiring 
to  own  those  concerns,  may  cause  them 
so  much  trouble  that,  not  wishing  to 
build  independent  plants,  the  minor  com- 
pany may  be  glad  to  dispose  of  its  prop- 
erty to  the  larger  concern.  Such  prac- 
tices are  those  of  persons  who  look  upon 
business  as  war.  It  is  asserted  with 
some  confidence  that  aside  from  the  ob- 
ligation of  the  publicly  created  corpora- 
tion to  serve  all  people  with  equity,  it  is 
good  business  policy  in  the  long  run  so  to 
do.  The  world  is  somewhat  slowly  learn- 


48  WHAT  IS  FAIR 

ing  that  mutual  confidence  and  helpful- 
ness, courtesy,  and  fair  dealing  make  for 
general  prosperity,  and  that  general  pros- 
perity is  better  than  prosperity  for  the 
few  and  poverty  for  the  many.  Until 
all  corporations  shall  realize  and  practice 
this  doctrine,  public  control  must  be  ex- 
ercised over  public  service  corporations, 
at  least,  to  see  that  there  is  no  inequity 
in  the  service  rendered  individuals  or 
communities.  It  must  be  constantly  re- 
membered that  government  exists  for  the 
benefit  of  the  governed  —  all  the  gov- 
erned. 

5.  Quality  of  Service.  —  Although 
some  railroad  companies,  some  street  car 
companies,  and  some  lighting  companies 
have  been  and  are  furnishing  a  quality 
of  service  poorer  than  is  contemplated  or 
called  for  in  their  charters  or  franchises, 
perhaps  it  remains  for  water  supply  com- 
panies to  be  most  negligent  in  this  re- 
spect. The  franchise  calls  for  pure  and 
wholesome  water,  but  the  people  must 
boil  the  company  water,  buy  drinking 
water  elsewhere,  while  paying  the  com- 


SUITABLE  PUBLIC  CONTROL  49 

pany  to  supply  it,  or  subject  themselves 
to  the  danger  of  contracting  water-borne 
disease.  The  franchise  calls  for  the  main- 
tenance of  a  given  pressure  at  all  times 
at  the  hydrants,  and  a  higher  pressure  to 
be  developed  within  a  time  limit  upon 
fire  call,  or  to  maintain  a  certain  number 
of  streams  of  specified  character.  The 
plant  designed  for  a  small  town  has  not 
kept  pace  with  the  growth  of  the  commun- 
ity and  the  pipes  are  too  small  to  deliver 
the  water  in  the  required  volume  at  the 
specified  pressure.  Moreover  the  city  is 
built  on  rolling  ground,  the  outlying  resi- 
dence districts  being  fifty  feet  or  more 
above  the  business  district  where  tests  are 
made,  and  there  is  no  specification  cover- 
ing the  place  of  the  test  stream.  The 
company  cannot  begin  to  meet  the  fran- 
chise requirement  of  volume  and  pressure. 
The  city  is  put  to  the  expense  of  buying 
and  maintaining  fire  engines  to  perform  a 
service  that  the  water  company  is  under 
contract  to  perform.  Perhaps  rates  have 
been  insufficient  to  enable  the  company 
bo  live  up  to  its  contract,  but  the  rates 


50  WHAT  IS  FAIR 

have  been  those  of  its  own  making. 
Whether  the  company  has  distributed  un- 
earned returns  or  failed  to  collect  proper 
charges,  it  is  at  fault.  Complaints  have 
been  made  in  the  press  and  by  personal 
statement  to  the  authorities  having  the 
power  to  control  the  quality  of  service, 
but  nothing  is  done.  The  matter  goes 
on  from  bad  to  worse  till  public  owner- 
ship is  advocated  and  perhaps  accom- 
plished, with  no  better  results  in  service 
than  before.  Now  that  the  public  is 
serving  itself  without  betterment  of  con- 
ditions, complaint  is  still  made,  but 
nothing  is  done  until  some  great  catas- 
trophe like  a  typhoid  epidemic  or  a  de- 
structive conflagration  occurs,  when  peo- 
ple wake  up  to  their  obligations  to  them- 
selves and  demand  better  service  from 
their  officers.  Experience  shows  that  the 
situation  is  likely  to  be  much  the  same 
under  municipal  or  private  ownership. 
Usually  in  the  case  of  water  works  the 
public  is  provided  with  the  power  of  con- 
trol, but  it  does  not  exercise  this  power 
at  the  right  time;  it  does  not  see  to  it 


SUITABLE  PUBLIC  CONTROL  51 

that  plans  on  which  the  property  is  built 
are  adequate,  and  when  once  the  plant  is 
built,  the  difficulty  of  correcting  errors  is 
so  great  that  the  correction  is  not  forced. 
The  people  growl  but  do  nothing.  En- 
mity to  the  corporation  grows,  rates  are 
questioned,  and  a  generally  unsatisfac- 
tory condition  results.  Service  such  as 
the  franchise  calls  for  would  have  devel- 
oped satisfaction  and  satisfactory  service 
will  be  paid  for  without  much  question 
of  rates  that  are  at  all  reasonable.  With 
respect  to  water  works  there  should  be 
not  only  authority  to  control  but  there 
should  be  actual  rational  control  from 
the  beginning. 

Formerly  illuminating  power  was  the 
chiefly  desirable  quality  of  gas.  With 
the  introduction  of  the  mantle  and  the 
development  of  the  gas  range  and  gas 
engine,  the  chiefly  desirable  quality  is 
heat  units  per  cubic  foot,  and  next  is  pres- 
sure. It  is  cheaper  to  make  gas  of  low 
thermal  value  than  it  is  to  make  it  of 
high  thermal  value,  and  it  takes  more  gas 
of  low  thermal  value  to  accomplish  an 


52  WHAT  IS  FAIR 

operation  requiring  a  certain  amount  of 
heat.  With  low  thermal  value,  lights  are 
dim  and  more  are  required;  with  low 
thermal  value,  gas  cooking  takes  longer 
and  consumes  more  gas,  and  with  low 
thermal  value,  internal  combustion  en- 
gines work  unsatisfactorily,  developing 
less  than  full  power.  Because  men  are 
greedy  and  often  unscrupulous,  just  as 
some  farmer  or  distributor  takes  as  much 
of  the  cream  from  the  milk  as  he  dares 
before  he  sells  it,  so  the  gas  operator 
fails  to  enrich  his  water  gas  with  the  oils 
that  give  it  heat  more  than  he  feels  to  be 
absolutely  necessary.  And  just  as  gov- 
ernment undertakes  to  govern  the  qual- 
ity of  milk  that  is  supplied  to  the  people, 
so  government  should  see  to  it  that  the 
gas  supplied  by  a  gas  plant,  either  private 
or  municipal,  is  of  the  quality  specified  in 
the  franchise  of  a  company,  or  satisfac- 
tory to  an  owning  public.  Practically 
none  of  the  older  gas  companies  are  at 
this  time  —  1917 --meeting  their  fran- 
chise requirements,  which  were  for  a 
given  illuminating  power  when  they  were 


SUITABLE  PUBLIC  CONTROL          53 

anything,  rather  than  a  given  heat  value. 
This  is  of  no  particular  consequence,  but 
the  provisions  of  the  franchise  should 
have  been  altered  to  meet  the  changed 
conditions  so  that  the  public  might  ex- 
ercise proper  control.  Practically  no  one 
wants  the  illuminating  power  specified, 
but  every  one  wants  heat  units  and 
many  people  are  paying  for  600  unit  gas 
and  getting  only  500  or  550  unit  gas. 
The  gas  has  value  in  proportion  to  its 
heat  units. 

At  present  for  lighting  or  other  pur- 
pose electric  energy  is  sold  most  often  by 
the  energy  unit,  so  much  per  kilowatt 
hour,  with  the  current  supplied  at  a  speci- 
fied pressure  or  potential.  Generally  it 
is  to  the  interest  of  the  company  to  keep 
the  pressure  close  to  that  specified  in 
order  to  give  satisfactory  service.  Drop- 
ping the  pressure  does  not  have  the  same 
effect  as  reducing  the  heat  units  of  gas. 
But  often  the  company  will  allow  out- 
lying districts  to  have  unsatisfactory 
service,  rather  than  go  to  the  expense  of 
stringing  larger  wires  or  placing  more 


54  WHAT  IS  FAIR 

transformers  to  keep  the  pressure  up. 
In  many  cases  energy  is  still  sold  on  a 
candle  power  basis  for  street  lights,  and 
in  some  cases  a  flat  rate  basis,  so  much 
per  month  per  lamp  of  given  rating,  for 
other  lighting  service.  When  energy  is 
sold  in  this  way  it  is  to  the  advantage  of 
the  supplying  company  to  let  the  pressure 
drop,  thus  making  and  selling  less  power 
than  is  paid  for.  In  administering  power 
contracts  for  the  use  of  alternating  current 
it  is  of  importance  to  control  the  fre- 
quency of  the  alternations  since  under 
some  conditions  it  may  be  advantageous 
to  the  producer  and  of  disadvantage  to 
the  consumer  to  vary  the  frequency  from 
the  specified  standard.  And  so  because 
of  the  greed  of  men,  just  as  government 
inspects  scales  and  measures  to  see  that 
the  greedy  farmer  or  grocer  or  coal  mer- 
chant does  not  sell  under  weight  or  under 
measure,  so  government,  which  exists  to 
protect  every  member  of  the  family  from 
the  greed  and  unruly  passion  of  every 
other  member,  must  exercise  control  over 
the  quality  of  service  of  electric  light  and 


SUITABLE  PUBLIC  CONTROL         r55 

power  companies  and  see  that  they  do 
not  sell  under  weight  or  under  measure. 

Street  railways  have  generally  been 
fairly  profitable  concerns  and  perhaps 
oftener  than  not  have  given  as  good  ser- 
vice as  could  be  expected.  But  in  many 
cases  inadequate  provision  is  made  for 
rush  hours  of  the  day;  sometimes  poor 
management  fails  to  keep  the  road  open 
during  storms;  and  occasionally  a  com- 
pany provides  less  than  decent  accom- 
modations for  its  patrons.  Government 
control  should  be  careful  here,  not  more 
excess  equipment  for  rush  hours  should 
be  provided  than  can  be  afforded,  but 
this  limit  should  be  determined  and  the 
proper  equipment  supplied.  Government 
cannot  manage  the  privately  owned  street 
railway,  but  reasonably  decent  equip- 
ment may  be  required,  if  the  franchise 
gives  the  power. 

Railway  companies,  being  to  a  consid- 
erable extent  in  competitive  business, 
have  learned  that  it  is  good  policy  to 
give  the  best  service  they  can.  Some  of 
them  are  not  earning  enough  to  keep  all 


56  WHAT  IS  FAIR 

of  their  properties  in  condition  to  render 
good  service,  and  some  have  been  guilty 
of  financial  operations  that  have  paid  to 
speculators  moneys  that  should  have 
gone  into  the  upkeep  of  their  properties. 
With  proper  capitalization,  proper  rates 
for  service,  a  proper  limit  to  profits,  and 
a  proper  intent  to  be  fair  in  dealing  with 
patrons,  railway  service  under  rational 
public  supervision  is  likely  to  be  fairly 
satisfactory. 

There  are  many  annoying  things  in  all 
services  that  cannot  be  controlled,  such 
as  surliness  of  servants,  failure  to  give 
definite  information  to  patrons  when  un- 
avoidable troubles  occur,  etc.,  but  these 
will  right  themselves  as  time  goes  on  and 
the  corporations  learn  that  public  con- 
fidence and  favor  are  their  best  asset. 
But  purely  and  only  because  of  the  greed 
of  men  is  it  necessary  to  exercise  public 
supervision  over  quality  of  service,  and 
this  necessity  is  not  confined  to  the  con- 
trol of  public  utility  corporations. 


CHAPTER  III 
RATE   CONTROL 

General  Statements.  -  -  Rate  control 
by  government,  while  generally  recog- 
nized as  altogether  proper  has  given  more 
trouble  than  any  other  item  of  regula- 
tion. Volumes  have  been  written  on  it, 
and  courts  have  wrestled  with  the  prob- 
lem through  pages  and  pages  of  decisions. 
It  is  not  hoped  to  solve  the  problem  in 
this  short  chapter.  Some  principles  that 
seem  to  be  fundamental  to  equitable  con- 
trol will  be  stated. 

Rate  control  should  be  exercised  with 
respect  to  three  matters: 

1.  To  see  that  the  rate  system  is  de- 
signed on  scientific  principles  that  pro- 
vide for  equitable  charges  to  all  classes 
of  consumers. 

2.  To  see  that  there  is  no  unjust  dis- 
crimination in  applying  the  system,  either 

57 


58  WHAT  IS  FAIR 

to  individual  consumers  of  service,  or 
localities  served. 

3.  To  see  that  the  rates  charged  pro- 
vide a  fair  return  to  the  corporation,  but 
no  more. 

The  problems  that  arise  are  most 
difficult  with  respect  to  railroads.  With 
respect  to  water  rates  in  cities,  the 
difficulties  lie  mostly  in  the  design  of  an 
equitable  system  of  rates.  With  respect 
to  electric  light  and  power  properties  the 
difficulties  are  perhaps  about  equal  in  the 
design  of  the  system  and  its  equitable 
application,  while  with  gas  properties 
there  appears  to  be  a  somewhat  less 
difficulty  than  with  water,  owing  simply 
to  the  absence  of  the  one  element  of  fire 
service.  The  telegraph  perhaps  offers  the 
simplest  problems;  the  telephone  some- 
what more  complex  problems. 

A  fundamental  principle  would  seem  to 
be  that  the  basis  of  charge  must  be  the 
cost  of  service.  The  value  to  different 
consumers  of  service  rendered  by  a  public 
utility  is  undoubtedly  a  variable.  For 
different  reasons  a  given  quantity  of  water 


RATE  CONTROL  59 

is  more  valuable  to  one  consumer  than 
to  another.  The  same  is  true  of  a  given 
amount  of  electric  power.  The  same  is 
true  of  a  given  number  of  ton  miles  of 
freight  service.  But  no  one  can  meas- 
ure the  actual  or  relative  values  of  these 
services.  It  is  not  a  practicable  thing  to 
do,  and  hence  the  only  basis  for  measur- 
ing charge  for  service  is  cost  of  service. 
It  is  not  possible  to  measure  exactly  the 
cost  of  the  particular  service  rendered  any 
particular  customer.  The  best  that  can 
be  done  is  to  get  as  near  to  this  cost  as 
is  practicable.  In  some  cases  the  charge 
based  on  cost  may  require  modification 
because  the  cost  of  the  service  to  a  given 
possible  customer  may  be  more  than  he 
will  pay,  since  it  is  more  than  a  perfectly 
satisfactory  similar  service  will  cost  him 
when  rendered  by  a  plant  of  his  own. 

Thus  a  high-grade  filtered  water  may 
be  supplied  in  the  mains  of  a  city  at  a 
certain  unit  cost.  A  consumer  of  large 
quantities  who  does  not  require  filtered 
water  may  be  able  to  supply  himself  for 
less  than  the  unit  cost  of  the  filtered 


60  WHAT  IS  FAIR 

water,  when  all  elements  of  cost  are  in- 
cluded. But  he  may  be  willing  to  pay 
more  than  the  actual  cost  of  the  pump- 
ing and  filtering,  and  thus,  if  served,  will 
pay  something  toward  the  fixed  charges 
on  the  property  and  so  somewhat  lessen 
the  burden  that  the  great  body  of  con- 
sumers would  have  to  bear  if  the  large 
quantity  consumer  were  not  supplied. 
Thus,  in  some  instances,  the  value  to  the 
consumer  will  modify  the  cost  basis  of 
charge,  and,  if  the  plant  is  owned  by  the 
government,  we  find  that  much  despised 
basis,  "  What  the  traffic  will  bear  "  a- 
dopted  by  the  public  itself  when  it  gets 
into  business  for  itself. 

Again  a  certain  possible  user  of  large 
quantities  of  electric  power  may  be  able 
to  supply  himself  with  other  power  at  a 
cost  less  than  the  complete  cost  of  fur- 
nishing him  power  from  the  public  plant. 
But,  as  before,  he  may  be  willing  to  pay 
the  full  operating  costs  and  something 
toward  the  fixed  charge,  thus  lowering 
the  average  charge  to  all  consumers  to 
something  less  than  it  would  be  were  the 


RATE  CONTROL  61 

user  of  large  quantities  not  served.  And 
again,  in  the  case  of  a  governmentally 
owned  plant,  we  find  the  public  charging 
with  perfect  propriety  "  What  the  traffic 
will  bear."  In  all  such  cases  judgment 
must  be  used,  short  term  contracts 
avoided,  and  the  practice  followed  only 
when  of  advantage  to  the  general  com- 
munity. 

Certain  classes  of  utilities,  notably 
water  supply  properties  and  electric  light 
and  power  properties,  and  gas  properties 
have  regularly  recurring  hours  of  maxi- 
mum demand  called  the  peak  load.  If 
the  whole  demand  could  be  averaged 
over  the  day,  the  machinery  could  be 
worked  more  economically,  and  it  could 
be  of  less  capacity.  Certain  classes  of 
customers  require  service  always  at  the 
time  of  peak  load  and  are  indeed  the 
creators  of  the  peak  demand.  Residences 
and  stores  are  apt  to  be  among  the  prin- 
cipal creators  of  the  peak  demand  of 
lighting  services.  Domestic  use  and  fire 
service  are  the  principal  creators  of  water 
supply  peaks.  It  should  be  clear  that 


62  WHAT  IS  FAIR 

those  who  create  the  peak  should  pay  the 
average  cost  and  the  extra  cost  due  to 
the  peak  demand.  Those  who  use  water 
or  power  only  during  the  off-peak  hours 
should  pay  no  more  than  the  average 
cost  and  there  may  be  good  argument  for 
an  even  less  charge.  Some  railroads  also 
have  peak  loads.  Street  railroads  are  of 
this  class  with  two  daily  peaks  for  which 
equipment  must  be  furnished,  which  lies 
idle  the  rest  of  the  day.  And  a  curious 
condition  is  noted  just  here;  the  public 
demand  for  reduced  rates  often  takes  the 
form  of  a  demand  for  a  reduced  rate  for 
those  who  must  ride  to  work  in  the  morn- 
ing and  return  in  the  evening,  those  who 
are  actually  the  creators  of  the  peak  load. 
The  demand  for  reduced  rates  at  these 
hours  is  a  demand  for  the  application  of 
"  what  the  traffic  will  bear,"  but  is  based 
not  on  value  of  service  nor  cost  of  service 
but  on  ability  to  pay.  Certain  suburban 
lines  of  steam  and  electric  roads  have  the 
same  sort  of  daily  peak  load.  Certain 
railroads  have  seasonal  peaks,  traffic  of 
one  kind  moving  in  large  quantities  in 


RATE  CONTROL  63 

one  direction  at  one  season  and  traffic 
of  another  kind  moving  in  the  opposite 
direction  at  another  season,  or  the  same 
season,  but  requiring  a  different  form  of 
equipment. 

Distribution  of  Fire  Service  and  Street 
Lighting  Costs.  -  -  Every  water  works 
property  is  built  larger  than  necessary 
for  domestic  and  manufacturing  demands 
to  provide  the  necessary  quantity  for 
emergency  fire  use.  The  distributing 
systems  are  always  larger  and  more 
costly  for  this  reason.  Reservoirs  may 
be  larger  or  pumping  plants  may  be  of 
greater  capacity  for  this  reason.  What 
beside  the  distributing  system  is  of 
greater  capacity  and  cost  will  depend 
on  the  kind  of  water  system  that  is 
in  use;  whether  a  gravity  supply  from 
the  mountains  without  pumps,  or  pumps 
and  large  storage  reservoirs,  or  direct 
pumping  with  small  equalizing  tanks  or 
reservoirs. 

Whatever  extra  cost  there  is  of  a  fixed 
character  due  to  the  extra  cost  of  the 
plant  should  be  assessed  to  the  property 


64  WHAT  IS  FAIR 

actually  or  potentially  protected.  Im- 
proved property  in  the  water  district  is 
actually  protected;  unimproved  property 
in  the  water  district  is  potentially  pro- 
tected, having  greater  value  by  reason  of 
being  in  the  water  district.  Just  how  the 
fire  service  cost  should  be  apportioned 
may  be  a  question,  but  it  is  doubtful  if  a 
fairer  distribution  is  practicable  than  in 
proportion  to  the  assessed  value  of  the 
properties  taxed.  Sometimes  when  water 
works  are  privately  owned,  the  city  pays 
what  purports  to  be  the  fire  and  sprin- 
kling cost,  and  collects  this  in  taxes  on 
property  within  the  water  districts,  but 
sometimes  on  all  properties  indiscrimi- 
nately according  to  assessed  value.  The 
same  practice  holds  sometimes  with  re- 
spect to  street  lighting  payments  of  a 
city  to  a  private  lighting  company,  and 
property  neither  actually  or  potentially 
served  with  lights  is  taxed  to  meet  the 
costs.  Whether  the  utility  is  privately 
or  publicly  owned,  only  those  properties 
actually  or  potentially  supplied  with 
service  should  pay  for  the  service. 


RATE  CONTROL  65 

Taxes.  —  Taxes  and  tax  apportion- 
ments are  curious  things.  Government 
must  be  paid  for  and  presumably  it  is 
more  valuable  to  the  individual  having 
much  property  to  be  protected  than  to 
the  individual  having  little  property  to 
be  protected.  As  a  matter  of  sentiment 
one  life  is  worth  as  much  as  another,  but 
as  economic  units,  cold-blooded  logic  says 
there  is  no  such  equality.  But  is  the 
man  of  wealth  worth  more  than  the  striv- 
ing, honest  worker  of  moderate  means? 
This  will  depend  on  how  he  uses  his  life 
—  and  who  shall  say?  The  best  that 
government  has  been  able  to  do  is  to  tax 
all  men  between  certain  ages  equally  a 
small  amount  called  by  various  names, 
and  all  persons  holding  property  another 
amount,  depending  on  the  nature  and 
value  of  their  holdings,  both  real  and 
personal.  Recently  in  the  United  States 
of  America,  an  income  tax  has  been 
levied  by  the  national  government. 
Taxes  are  collected  from  public  utility 
companies  and  are  generally  looked  upon 
as  an  expense  to  be  deducted  from  earn- 


66  WHAT  IS  FAIR 

ings  before  the  net  return  that  is  called 
fair  return  is  computed.  Some  busi- 
ness men  may  deduct  taxes  before  esti- 
mating their  net  returns.  There  may  be 
a  good  deal  of  circular  reasoning  here 
but  it  would  seem  that  the  man  who  esti- 
mates his  net  return  after  deducting 
taxes,  pays  no  taxes  on  his  own  property, 
but  collects  his  tax  from  those  whom  he 
serves.  This  certainly  will  be  true  if  his 
net  return  is  limited  by  law  or  regulation. 
He  helps  pay  the  tax  of  the  persons  who 
serve  Jiim  and  perhaps  an  equitable  end 
is  reached.  But  if  property  is  taxed  in 
proportion  to  its  value,  then,  omitting 
certain  items  of  personal  property  that 
have  a  market  value  but  no  earning  ca- 
pacity, except  as  potential  earning  ca- 
pacity may  be  represented  by  a  fair  in- 
terest rate  on  their  cost  or  worth,  that 
value  should  be  estimated  not  on  what 
the  property  cost,  nor  on  what  it  would 
cost  to  reproduce  it,  but  on  its  earning 
capacity,  actual  or  potential.  Net  rental 
value  is  the  fair  value  of  real  estate;  net 
earning  capacity  is  the  measure  of  fair 


RATE  CONTROL  67 

value  of  a  business.  And  this  suggests 
that  the  income  tax  is  a  fairer  tax  than 
a  tax  that  is  based  on  what  are  called 
physical  values  which  in  general  are  costs, 
actual,  or  estimated. 

Men  invest  in  government  bonds  bear- 
ing 3J  per  cent  interest  rather  than  in 
bank  deposits  paying  4  per  cent  because 
the  money  loaned  to  government  pays 
no  tax  and  the  security  is  gilt-edged. 
As  a  matter  of  fact,  of  course,  the  money 
loaned  to  government  does  pay  a  tax 
represented  by  a  part~of  the  difference 
between  bank  interest  and  bond  interest, 
the  remaining  difference  representing  the 
difference  in  the  estimated  value  of  the 
security. 

When  capital  is  loaned  to  a  business, 
the  owner  of  the  capital  looks  for  a  cer- 
tain net  return,  and  the  interest  he 
charges  is  based  in  part  on  what  tax  he 
must  pay  on  his  income  or  money  and 
credit.  Thus  the  user  of  the  money  pays 
the  tax  and  charges  it  up  to,  and  collects 
it  from,  those  whom  the  business  serves. 
It  is  generally  recognized  that  a  tenant 


68  WHAT  IS  FAIR 

pays  the  property  tax  of  his  landlord, 
but  with  respect  to  temporary  taxes  for 
emergencies,  perhaps  this  is  not  so. 

When  government  owns  and  operates 
its  own  utilities,  it  probably  collects  in 
the  form  of  rates  or  otherwise,  sufficient 
taxes  to  pay  the  cost  of  the  service,  but 
collects  no  profit,  nor  properly  any  tax 
to  be  devoted  to  other  expenses  of  gov- 
ernment. When  government  allows  a 
private  person  or  corporation  to  own  and 
operate  its  utilities,  it  must  allow  the 
cost  of  the  service  and  a  fair  profit  or 
wage  for  service.  If  a  tax  for  general 
purposes  is  deducted  from  earnings  be- 
fore the  limited  fair  return  is  computed, 
then  the  people  served  pay  the  tax  on  the 
utility  property,  a  cost  they  would  not 
be  charged  with  if  the  public  owned  its 
own  plant,  and  one  which  does  not  go 
to  the  utility  owner  as  a  part  of  his  wage 
for  service,  but  an  amount  that  the  whole 
public  would  have  to  pay  in  some  other 
way  if  not  paid  through  the  utility  rates. 
If,  on  the  other  hand,  the  limited  fair 
return  is  computed  before  deducting 


RATE  CONTROL  69 

taxes,  the  utility  seems  to  be  paying  its 
share  of  the  cost  of  government.  And 
with  respect  to  emergency  taxes,  perhaps 
this  would  be  true.  But  again  capital 
wants  its  fair  return,  and  unless  compe- 
tition for  the  use  of  capital  fixes  the  rate, 
capital  will  not  go  into  utility  ventures 
for  less  than  its  fair  return  and  the  tax 
again  comes  back  on  the  users  of  the 
utility  service.  That  is  to  say  in  fixing 
the  limit  of  fair  return,  the  public  takes 
taxes  into  account.  Taxing  theories  and 
methods  are  curious  as  was  stated  in  the 
beginning,  but  it  is  advanced  that  to  con- 
form as  fairly  as  possible  with  theories 
and  methods  presently  in  use,  public 
utility  corporations  should  be  untaxed, 
but  the  incomes  from  the  holdings  of 
bondholders  and  stockholders  should  be 
taxed.  Whether  this  tax  shall  be  col- 
lected from  the  corporation  and  deducted 
from  interest  or  dividend  payments,  or 
collected  from  the  individual  security 
holders  may  depend  on  the  nature  and 
the  location  of  the  securities.  That  is 
not  a  matter  of  concern  here,  the  only 


70  WHAT  IS  FAIR 

point  of  interest  here  being  the  sugges- 
tion that  taxes  are  not  to  be  included  as 
an  expense  when  devising  a  system  of 
charges  to  be  equitable  to  the  commu- 
nity served  and  to  provide  just  a  fair  re- 
turn for  the  service,  and  that  the  corpo- 
ration as  such  is  not  to  be  taxed.  Other- 
wise users  of  service  pay  a  greater  part 
of  the  cost  of  government  than  those 
who  do  not  use  the  service.  Whether 
or  not  this  can  be  avoided  depends  on 
the  tax  system. 

Wholesale  vs.  Retail  Charges.  —  With- 
out doubt  rail  service  costs  less  when  it 
is  performed  in  car  load  lots  than  when 
performed  in  less  units.  Although  some- 
times denied,  rail  service  costs  less  when 
performed  by  train  loads  than  in  single 
car  loads.  When  service  costs  less,  then, 
on  a  cost  basis,  less  should  be  charged 
for  it.  But  the  right  of  the  user  of  large 
quantities  of  gas,  water,  or  electric  power 
to  a  less  rate  than  his  neighbor,  who  uses 
a  less  amount,  is  not  so  easily  estab- 
lished. Charges  for  these  services  may  be 
divided  into  four  elements  based  on  cost. 


RATE  CONTROL  71 

1.  Peak  load  costs,  sometimes  varying 
with  the  quantity  used  and  sometimes 
not,  as  in  the  fire  service  cost  of  a  water 
supply  service. 

2.  Consumer  costs,  varying  with  the 
class  of  the  consumer  but  not  with  the 
quantity  of  product  consumed;   as  read- 
ing meters,  interest,  depreciation,  and  re- 
pairs on  meters,  etc.,  which  are  properly 
charged  so  much  per  consumer  having  a 
given  sized  service. 

3.  Output  costs,  varying  closely  with 
the  quantity  of  product,  such  as  cost  of 
fuel,  oil,  waste,  etc.,   in  a  pumping  or 
power  plant.     This  element  does  not  ex- 
ist in  connection  with  a  gravity  water 
supply. 

4.  Fixed  charges,  less  the  part  of  this 
item  included  in  peak  load  costs,  and  in- 
cluding general  superintendence  and  items 
of  expense  not  assignable  to  the  other  ele- 
ments.    This  item  should  probably  vary 
with  the  sum  of  the  other  three  costs  on 
the   theory   that   those   who   cause   the 
greatest    expense    receive    the    greatest 
value  and  have  the  largest  interest  in  the 


72  WHAT  IS  FAIR 

overhead  of  the  property.  In  the  inter- 
est of  simple  publicity  and  bookkeeping 
a  simpler  division  of  charges  may  be  de- 
sirable even  though  it  be  somewhat  less 
equitable. 

As  has  been  pointed  out  under  another 
head  the  off  peak  consumer  has  a  valid 
claim  to  a  lower  rate  than  the  peak  load 
customer,  but  this  is  not  because  he  is 
entitled  to  a  lower  output  rate,  but  be- 
cause the  peak  load  element  is  omitted 
from  his  charge.  If  at  the  same  time 
he  is  a  user  of  large  quantities  of  product 
and  tends  by  his  large  use  to  keep  the 
plant  operating  at  a  higher  efficiency 
than  would  be  possible  without  his  serv- 
ice, he  may  have  a  reasonable  claim  to  a 
less  output  rate  as  well.  This  is  primarily 
because  he  is  an  off  peak  customer;  the 
peak  load  customer  making  equal  quan- 
tity demands  in  general  has  no  such  claim. 
There  is  little  justification,  therefore,  for 
a  general  output  rate  of  several  steps 
without  reference  to  the  relation  of  the 
hour  of  demand  to  that  of  the  peak  load. 

If  the  output  rate  of  the  users  of  large 


RATE  CONTROL  73 

quantities  of  product  is  made  the  same 
as  that  of  other  users,  except  as  they 
are  off  peak  customers,  the  general  level 
of  rates  will  be  lowered  and  those  least 
able  to  pay  will  be  favored  as  compared 
with  their  situation  under  the  ordinary 
step  system.  The  biblical  adage  "  Unto 
him  that  hath  shall  be  given  "  may  be 
violated,  but  probably  in  the  interest  of 
the  larger  number  and  to  the  benefit  of 
society.  Too  great  development  of  off 
peak  service  may  produce  a  new  peak, 
which  should  be  duly  recognized.  It  is 
not  unusual  for  light  and  power  com- 
panies to  hold  domestic  consumers  to  be 
the  peak  load  creators  and  to  charge 
them  accordingly.  This  is  not  right. 
As  has  been  said  every  consumer  at  a 
peak  load  hour  is  a  peak  load  creator 
and  should  be  so  charged. 

A  distinction  in  developing  this  item 
of  rate  system  design  must  be  made  be- 
tween those  properties  that  manufacture 
and  store  their  product  and  those  that 
must  make  their  product  as  it  is  sold. 
Gas  and  some  water  properties  can  oper- 


74  WHAT  IS  FAIR 

ate  steadily  at  high  efficiency,  storing 
the  surplus  of  the  off  peak  hours  against 
the  use  of  the  peak  load  hours.  Electric 
light  and  power  companies,  railroad  com- 
panies of  all  kinds,  and  telephone  and 
telegraph  companies  manufacture  their 
product  as  it  is  sold,  but  there  is  still  a 
difference  between  them.  All  must  main- 
tain a  plant  and  force  equal  to  the  peak 
demand  and  the  necessary  emergency 
surplus,  and  the  electric  light  and  power 
companies  and  telegraph  and  telephone 
companies  sell  their  product  as  fast  as 
it  is  made,  telegraph  companies  making 
an  output  charge,  telephone  companies  a 
mixed  charge.  But  the  railroad  com- 
pany must  practically  always  manufac- 
ture more  than  it  sells  and  the  waste 
must  be  paid  for  by  those  who  buy  the 
used  product.  The  railroad  company 
manufactures  transportation  and  every 
time  a  passenger  train  goes  over  a  divi- 
sion, or  a  street  car  goes  over  its  route, 
a  certain  number  of  passenger  miles  of 
transportation  are  manufactured.  If  the 
train  or  car  is  not  filled  all  the  way,  some 


RATE  CONTROL  75 

of  these  passenger  miles  are  lost.  This 
is  of  less  consequence  with  the  street  car 
because  the  universal  charge  is  per  trip 
and  not  by  the  mile.  (It  may  be  noted 
incidentally  that  the  service  value  given 
different  customers  of  the  street  car  for  a 
common  price  is  very  different  and  a 
proper  adjustment  of  this  matter  should 
be  made  if  possible.)  Every  time  a 
freight  train  goes  over  a  division,  a  cer- 
tain number  of  ton  miles,  or  pound  miles, 
or  hog  miles,  or  horse  miles,  or  cattle 
miles,  or  what  not  miles  are  manufac- 
tured. Very  rarely  are  they  all  sold. 
Every  shipper,  who  helps  to  fill  a  car, 
helps  to  reduce  the  cost  per  ton  mile; 
every  additional  passenger  in  a  train 
helps  to  reduce  the  cost  per  passenger 
mile;  hence  an  argument  for  a  lower  rate 
to  the  shipper  of  large  quantities  or  user 
of  much  passenger  service,  and  also  for 
the  low  rate  to  a  shipper  who  will  not 
ship  at  a  higher  rate,  and  the  passenger 
who  will  go  on  an  excursion  only  at  a 
low  rate.  This  will  be  further  discussed 
under  another  head. 


76  WHAT  IS  FAIR 

' 'What  the  Traffic  will  Bear"  and 
Some  Other  Things.  —  To  consider  fully 
all  the  problems  of  a  rate  system  for 
railroad  service  would  require  a  volume, 
or  possibly  more  than  one  volume  of  con- 
siderable size. 

There  is  one  basis  of  rate  making  that 
has  been  much  despised  by  the  public 
generally,  that  really  often  has  much  to 
commend  it,  and  indeed  in  some  cases, 
as  has  been  shown  under  another  head, 
is  the  only  possible  basis  whether  the 
utility  is  publicly  or  privately  owned,  and 
this  basis  is  "  What  the  traffic  will  bear." 

What  the  traffic  will  bear  is  a  term  re- 
proachfully used  by  the  public  when  dis- 
cussing utility  rates,  and  particularly 
railroad  rates.  But  let  consideration  be 
given  to  general  business.  A  successful 
merchant  purchases  a  bill  of  goods.  His 
common  practice  is  to  add  50  per  cent 
to  the  invoice  price  of  the  articles  billed 
to  make  his  selling  price.  Of  course  this 
rate  varies  and  on  some  articles  some 
dealers  add  very  little,  but  50  per  cent 
is  a  not  uncommon  average.  Out  of  this 


RATE  CONTROL  77 

50  per  cent  gross  profit  the  merchant  pays 
all  his  expenses,  and  hopes  to  realize  a 
reasonable  net  profit  on  his  business  and 
on  his  invested  capital.  But  he  notes  a 
few  articles  among  those  purchased  that 
he  thinks  will  stand  a  somewhat  higher 
price  and  still  sell.  He  uses  his  judg- 
ment, places  the  higher  selling  price  on 
the  tag  and  is  at  once  guilty  —  if  that  is 
the  proper  word  to  use  —  of  charging 
what  the  traffic  will  bear.  The  fact  that 
the  merchant  is  in  competitive  business 
makes  no  difference  with  this  practice  as 
a  practice.  Competition  may  limit  the 
price  but  the  method  still  obtains.  This 
is  not  a  guess  at  what  the  merchant  does; 
this  is  what  he  does.  He  charges  what 
the  traffic  will  bear.  But  the  merchant 
is  one  of  the  middle  men,  while  the  rail- 
road, the  water  company,  and  the  light 
and  power  companies  are  producers,  man- 
ufacturers. And  the  practice  of  the  man- 
ufacturer does  not  differ  from  that  of  the 
merchant.  For  certain  staples  a  regular 
profit  rate  may  be  added  to  cost,  but  this 
varies  with  many  conditions,  and  when 


78  WHAT  IS  FAIR 

a  new  article  is  put  on  the  market  the 
selling  price  is  fixed  at  what  the  traffic 
will  bear. 

What  the  traffic  will  bear  is  not  all 
that  can  be  charged  without  discourag- 
ing or  preventing  the  purchase  of  service 
or  goods.  It  is  what  is  sometimes  called 
the  monopoly  price,  that  price  which,  con- 
sidering the  factors  of  quantity,  cost,  and 
price,  will  yield  the  largest  net  return  to 
the  seller.  And  if  everyone  is  charging 
what  the  traffic  will  bear,  every  one  is 
getting  the  most  that  he  can  for  the  serv- 
ice he  renders.  And  is  not  this  a  de- 
sirable condition  in  a  business  commu- 
nity not  completely  controlled  by  govern- 
ment? It  does  not  mean  the  simple 
quiet  life  that  may  be  really  the  most  de- 
sirable achievement  of  society;  it  means 
what  is  generally  called  prosperity  and 
progress,  whether  or  not  the  resulting 
appearance  of  prosperity  and  progress  is 
of  the  real  things.  It  does  not  mean  war 
nor  the  application  of  "  civilized?  "  or 
barbarous  war  methods  to  business.  It 
often  means  helpfulness  to  the  develop- 


RATE  CONTROL  79 

ment  of  business  and  real  economy  as 
has  been  pointed  out  in  the  discussion  of 
whole  ale  vs.  retail  charges.  The  devel- 
opment of  the  Ford  Automobile  industry 
is  an  example  in  point. 

But  in  connection  with  public  utilities 
it  should  be  the  price  charged  only  when 
it  will  serve  to  lower  the  average  cost  of 
service  to  the  public,  or  will  develop  a 
legitimate,  natural,  and  desirable  busi- 
ness that  cannot  be  developed  without 
some  concession  in  rates  from  the  aver- 
age of  its  class.  This  is  true,  of  course, 
only  when  the  utility  is  under  rational 
public  regulation,  or  the  practice  is  nec- 
essary to  produce  the  fair  return  to  which 
the  company  owner  is  entitled.  For  a 
business  so  varied  as  railroad  service  in 
which  the  cost  of  a  particular  service 
cannot  be  determined,  what  the  traffic 
will  bear  is  the  rational  basis  for  a  ten- 
tative rate  design.  If  it  is  found  to  yield 
more  than  is  judged  to  be  a  fair  return, 
then  under  proper  regulation  provided 
for  in  the  charter  of  the  utility  corpora- 
tion, a  general  scaling  of  rates  may  be 


80  WHAT  IS  FAIR 

ordered,  or  certain  necessaries  of  all 
people  may  be  selected  for  lower  rates  to 
reduce  the  earnings  to  the  proper  fair 
return.  The  business  cannot  be  made 
to  pay  more  than  the  return  based  on 
what  the  traffic  will  bear,  and  if  this  is 
not  the  full  limit  of  fair  return,  the  busi- 
ness must  be  classed  as  a  failure  or  only 
moderately  successful. 

What  the  traffic  will  bear  is  not  always 
the  wicked  thing  it  has  been  so  often 
thought  to  be;  it  is  not  necessarily  an 
oppressive  rate;  it  is  what  all  business 
men  are  trying  to  charge  whether  they 
are  in  competitive  or  monopoly  busi- 
nesses; and  it  is  improper  in  the  case  of 
a  public  utility  only  because  and  when  it 
is  oppressive  or  produces  a  return  larger 
than  the  fair  return  to  which  a  corpora- 
tion performing  a  public  function  is  en- 
titled. It  is  just  as  improper  when  a 
dealer  in  necessities  takes  advantage  of 
troublous  times  to  oppress  the  people. 

It  may  be  a  question  for  argument,  but 
it  is  asserted  with  some  confidence  that 
a  rate  system  should  not  destroy  natural 


RATE  CONTROL  81 

advantages  of  location.  In  this  is  in- 
volved the  long  and  short  haul  question, 
water  or  other  competition,  and  possibly 
some  sociological  considerations.  Should 
a  place  located  on  a  high  mountain  and 
reached  over  steep  grades  and  sharp 
curves  costly  to  operate,  have  the  same 
rate  from  a  given  center  as  a  more  fa- 
vorably located  place  with  the  same  length 
of  haul  over  a  fairly  straight  line  with 
low  grades  operated  at  much  less  cost? 
Is  a  railroad  expensively  built  through  a 
hilly  country  between  two  termini,  but 
necessarily  so  built  to  give  needed  serv- 
ice to  the  territory  through  which  it 
passes,  and  relatively  costly  to  operate 
over  high  grades  and  sharp  curves,  en- 
titled to  the  same  rate  of  return  as  the 
less  costly  line  built  with  low  grades  and 
light  curves,  along  a  valley  between  the 
same  termini,  and  so  built  to  give  a 
needed  service  to  the  territory  through 
which  it  passes?  And  if  so,  how  is  this 
to  be  brought  about?  Rates  between 
the  termini  must  be  the  same,  or  even  less 
by  the  probably  slower  hill  line  as  an 


82  WHAT  IS  FAIR 

offset  to  the  longer  time  required  for  the 
trip,  unless  through  business  is  neglected 
by  this  line.  Can  intermediate  rates  be 
the  same  per  unit  and  give  equal  rates 
of  return  to  the  two  properties?  If  gov- 
ernment owns  and  operates  the  two  lines, 
what  will  it  do  if  it  is  not  operating  them 
as  a  revenue  producing  function,  but  only 
to  earn  the  costs? 

What  real  advantage  have  towns  along 
the  lower  Mississippi  river  over  towns 
along  a  somewhat  parallel  line  some  dis- 
tance east  or  west,  by  reason  of  the  actual 
or  potential  water  competition  made  pos- 
sible by  costly  work  performed  by  gov- 
ernment to  create  a  free  open  channel, 
and  what  advantage  have  towns  along 
the  Erie  Canal  over  other  towns  in  New 
York,  by  reason  of  the  expenditure  of 
millons  on  millions  of  dollars  of  public 
money  to  provide  a  free  water  highway? 
Just  how  much  advantage  has  San  Fran- 
cisco over  Fresno  on  shipments  from 
New  York,  and  on  shipments  from  St. 
Louis,  and  on  shipments  from  Chicago 
and  on  shipments  from  Denver,  because 


RATE  CONTROL  83 

of  water  competition  through  the  Pan- 
ama canal?  What  would  government  do 
in  these  cases  if  it  were  conducting  the 
rail  transportation  but  not  the  water 
transportation,  and  what  would  it  do  if 
it  were  conducting  both?  On  the  answer 
to  "  What  should  government  do?"  should 
depend  the  view  of  regulating  bodies 
toward  the  properties  under  their  author- 
ity. 

But  it  is  suggested  that  the  advantage 
of  favorable  location  should  not  lie  wholly 
with  the  public  served.  The  more  favor- 
ably located  railroad  should  be  allowed  a 
more  favorable  return  if  this  can  be  done 
without  destroying  the  advantage  of  lo- 
cation of  the  communities  it  serves.  The 
fair  return  is  not  so  nearly  a  fixed  quan- 
tity for  railroads  as  it  is  for  utilities  of 
other  kinds. 

Discrimination  and  Fair  Return. — 
Concerning  discrimination  and  fair  re- 
turn little  can  be  said  without  going  into 
a  long  catalog  of  improper  practices  of 
utility  corporations,  on  the  one  hand,  or 
discussing  the  question  of  Chapter  Four 


84  WHAT  IS  FAIR 

further  on  the  other  hand.  All  right 
thinking  men  abhor  unjust  discrimina- 
tion of  any  kind  or  the  display  of  unwar- 
ranted favoritism  in  any  activity  of 
business  or  political  life,  and  it  is  fair  to 
say  that  almost  all  utilities,  and  nota- 
bly railroad  companies,  have  been  gross 
offenders  in  these  directions,  with  respect 
to  both  individuals  and  localities.  No 
excuse  for  them  is  offered.  Wherever 
they  are  still  offending  they  should  be 
punished  and  the  practices  stopped.  And 
this  is  about  all  there  is  to  be  said,  except 
that  in  some  cases  what  appear  to  be 
improper  discriminations  will  develop  on 
investigation  to  be  altogether  proper 
differences  based  on  different  conditions 
of  service.  Thus  great  care  is  needed  in 
the  examination  of  such  intricate  things 
as  railroad  rates  in  order  to  establish  the 
fact. 

With  respect  to  the  duty  of  a  regulat- 
ing body  to  see  that  the  utilities  under 
its  supervision  earn  fair  return  and  no 
more,  the  following  may  be  suggested. 
When  an  engineer  is  employed  to  super- 


RATE  CONTROL.  85 

vise  the  construction  of  a  great  work  be- 
ing performed  under  contract,  it  is  his 
duty  to  help  the  progress  of  the  work. 
He  is  there  to  see  that  no  dishonest  work 
or  improper  material  goes  into  the  struc- 
ture if  attempts  are  made  to  defraud  in 
these  ways;  but  just  as  much  is  it  his 
duty  to  do  what  he  can  to  forward  the 
work,  assisting  rather  than  nagging  or 
hindering  the  contractor,  all  to  the  ad- 
vantage of  his  employer.  Just  as  is  the 
duty  of  the  engineer  in  supervising  a  great 
work  so  is  the  duty  of  a  public  utility 
regulating  body  twofold  —  positive  and 
negative.  It  is  just  as  much  the  duty  of 
such  a  body  to  try  to  make  the  attitude 
of  the  public  toward  the  corporation  to 
be  fair,  as  it  is  to  insist  that  the  corpora- 
tion shall  be  fair  in  its  dealings  with  the 
public.  Some  regulating  bodies  have 
succeeded  very  well  in  their  dual  task  5 
others  have  failed,  because  they  have 
sought  to  curry  favor  with  an  uninformed 
and  properly  suspicious  public,  rather  than 
to  learn  the  truth  and  inform  the  people. 
Full  publicity  concerning  its  affairs  is  the 


86  WHAT  IS  FAIR 

safety  valve  for  every  public  utility 
owner,  and  regulating  bodies  should  see 
to  it  that  such  publicity  is  had  together 
with  properly  fair  interpretations  of  all 
statements  or  practices  likely  at  all  to 
arouse  questions.  Fair  dealing  and  open 
minds  are  essential  to  comfortable  living 
together  of  people  with  people,  corpora- 
tions with  corporations,  for  they  are  but 
people  with  people,  and  people  with  cor- 
porations. 


CHAPTER  IV 
WHAT  IS  FAIR  RETURN 

Men  go  into  business  to  make  money. 
Men  invest  their  money  in  business  to 
make  more  money.  In  the  United  States 
of  America  at  this  time,  if  the  business  is 
an  established  business  seemingly  certain 
to  continue  without  serious  interruption, 
men  may  be  found  who  will  invest  their 
money  in  it,  if  it  seems  quite  certain  to 
yield  about  5  per  cent  on  the  investment. 
If  it  is  a  little  less  certain,  6  or  7  per  cent 
will  be  required  to  interest  persons  with 
money  to  invest,  while  if  it  is  a  brand- 
new  business  just  starting,  the  element 
of  chance  will  require  the  prospect  of  a 
much  higher  rate  to  induce  men  to  put 
their  money  into  the  venture. 

When  one  enters  business  for  himself, 
to  be  managed  by  himself,  he  hopes  to 
make  the  business  earn  for  him : 

1.   Its  operating  expenses  including  a 

87 


88  WHAT  IS  FAIR 

reasonable  salary  for  himself  and  such 
depreciation  allowances  as  may  be  nec- 
essary to  maintain  the  involved  physical 
property  in  normal  condition. 

2.  At  least  savings  bank  interest  on  the 
money  he  has  invested. 

3.  A  profit  that  shall  be  commensu- 
rate with  the  risk  involved  in  the  business 
and  the  magnitude  of  the  business  done. 
This  last  measure  of  a  proper  profit  - 
the  magnitude  of  the  business  done  —  is 
sometimes  overlooked. 

When  one  invests  his  money  in  a  cor- 
poration, the  business  of  which  is  new 
and  untried  and  is  to  be  managed  by 
certain  officers  and  employes  of  the  cor- 
poration, he  expects  that  his  money  so 
invested  will  earn  at  least  savings  bank 
interest  and  a  profit  commensurate  with 
the  risk  involved  in  the  business. 

One  who  invests  his  money  in  a  new 
banking  business,  one  of  the  more  stable 
and  certain  of  businesses,  expects  that 
his  money  will  earn  not  less  than  10  per 
cent  and  hopes  for  and  usually  receives 
considerably  more  than  10  per  cent, 


WHAT  IS  FAIR  RETURN  89 

which  is  partly  paid  in  dividends  and 
partly  by  payments  to  the  surplus  fund, 
which  is  really  a  reinvestment  of  profit 
that  increases  the  value  of  the  stock. 
When  the  business  is  well  established  and 
is  earning  an  average  of  10  per  cent  on 
the  par  value  of  its  stock,  men  will  be 
willing  to  invest  in  this  stock  at  such 
prices  as  to  make  their  return  less  than 
10  per  cent,  and  often  as  little  as  5  per 
cent  on  the  investment. 

One  of  the  great  banks  of  New  York 
pays  regular  dividends  of  25  per  cent 
quarterly,  or  a  return  better  than  100 
per  cent  annually,  and  occasional  extra 
dividends  of  100  per  cent,  and  its  stock 
is  quoted  at  more  than  40  times  its  par 
value.  It  does  an  enormous  business  with 
a  relatively  small  capital.  It  charges  for 
its  service  no  more  than  its  service  is 
worth  else  it  could  not  do  the  business 
in  competition  with  other  banks.  There 
are  numerous  other  banks  whose  stock 
is  worth  several  times  its  par  value  be- 
cause of  the  large  returns  on  the  origi- 
nally invested  capital,  and  the  existence 


90  WHAT  IS  FAIR 

of  a  large  surplus,  which  returns  and  sur- 
plus have  been  realized  by  doing  a  large 
business  with  a  relatively  small  capital. 

When  one  goes  into  any  manufactur- 
ing business  or  into  a  contracting  busi- 
ness involving  considerable  risks  he  fig- 
ures to  receive  a  large  return  because  of 
the  risk  of  actual  loss  or  very  small  or 
irregular  return,  which  frequently  results. 
He  plans  to  make  from  50  to  100  per  cent 
if  all  conditions  prove  favorable  and  to 
make  10  per  cent  if  conditions  prove  to 
be  as  unfavorable  as  he  thinks  at  all  pos- 
sible. Not  infrequently  conditions  prove 
more  unfavorable  than  he  thought  possible 
or  he  makes  some  mistake  or  oversight  in 
his  estimate  and  as  a  result  he  loses  money; 
on  the  other  hand  occasionally  conditions 
prove  to  be  much  more  favorable  than  he 
had  hoped  for  and  he  makes  a  large  profit. 
The  thinking  public  permits  and  expects 
such  profits. 

The  rate  of  return  is  frequently  figured 
in  ordinary  business,  not  as  a  rate  on  the 
amount  of  capital  actually  invested  but 
as  a  per  cent  of  the  business  done.  A 


WHAT  IS  FAIR  RETURN  91 

corner  grocer  in  the  suburbs  charges  a 
large  profit  rate  on  very  small  sales  that 
he  may  earn  a  modest  living  without  ac- 
tual profit,  while  a  Marshall  Field,  a 
Wanamaker,  or  a  Woolworth  collects  a 
smaller  profit  on  very  large  sales  that  he 
may  earn  for  himself  or  his  company  a 
moderate  rate  of  return  on  the  invested 
capital,  which  moderate  rate  will  yield  a 
large  annual  income. 

If  on  a  capital  of  $1000  a  small  dealer 
does  a  business  aggregating  $10,000  gross, 
he  hopes  to  make,  say,  10  to  15  per  cent 
on  the  $10,000,  or  100  to  150  per  cent  on 
the  capital  actually  invested,  but  this  is 
not  profit;  it  is  salary,  sometimes  mistaken 
for  profit.  As  the  extent  of  his  operations 
increases  and  he  eventually  does  a  business 
of  $100,000  a  year,  he  may  hope  for  a  net 
return  of  5  per  cent  or  more  on  his  gross 
business  over  and  above  salary.  As  his 
business  grows  he  invests  more  capital 
which  he  takes  from  his  profits  or  bor- 
rows from  the  bank,  and  he  does  a  busi- 
ness amounting  to  $1,000,000  gross.  On 
this  he  hopes  to  earn  from  2\  to  3  per 


92  WHAT  IS  FAIR 

cent,  or  perhaps  15  to  25  per  cent  on  his 
actually  invested  capital.  When  his  busi- 
ness amounts  to  $10,000,000  a  year  he  is 
content  with  perhaps  2  per  cent  profit  or 
even  less  on  the  gross  volume  of  the  busi- 
ness since  this  will  yield  from  10  to  15 
per  cent  on  his  actually  invested  capital 
and  this  has  gotten  to  be  so  large  that  a 
smaller  rate  of  return  enables  him  to  live 
in  the  manner  he  chooses,  and  the  busi- 
ness is  established  and  safe.  He  could 
probably  incorporate  the  business  and 
sell  the  stock  on  a  5  or  6  per  cent  return 
basis,  pocket  the  resulting  profit,  invest 
it  in  safe  securities  yielding  4  or  5  per  cent 
and  spend  the  remainder  of  his  days  in 
such  activities  as  might  please  him.  This 
is  the  successful  man  —  the  more  than 
average  successful  man.  It  is  a  lament- 
able fact  that  the  average  man  in  busi- 
ness is  a  failure  so  far  as  his  business 
results  are  concerned.  He  may  not  go 
into  bankruptcy  but  he  takes  $20  a  week 
or  $100  a  month  out  of  the  business  as  a 
salary,  charges  it  in  expenses  and  makes 
no  profit  at  all,  not  even  interest  on  his 


WHAT  IS  FAIR  RETURN  93 

actually  invested  capital.  Such  a  result 
cannot  be  called  success. 

These  considerations  seem  to  indicate 
that  in  private  business  there  is  no  rate 
of  return  that  can  be  called  in  general  a 
fair  rate  of  return.  Any  business  man 
or  corporation  seems  to  be  permitted  by 
common  public  consent  to  earn  any  rate 
of  return  on  the  actually  invested  capital 
that  is  possible  by  honorable  dealing. 

In  general  business  then  there  is  no 
standard  for  determining  a  fair  rate  of 
return.  The  laborer  is  worthy  of  his  hire 
and  whether  he  makes  his  talents  return 
an  hundredfold  or  only  tenfold,  he  has 
earned  no  more  than  a  fair  return  if  he 
has  dealt  honestly  and  has  not  defrauded 
or  oppressed  his  neighbor.  Indeed,  a  fair 
return  in  general  business  might  be  de- 
nned as  any  return  a  business  is  able  to 
earn  by  fair  and  honorable  methods. 

Does  the  same  definition  hold  for  pub- 
lic utility  properties?  In  considering  this 
question  it  must  be  remembered  that  men 
go  into  the  business  of  furnishing  public 
service  —  service  that  is  generally  recog- 


94  WHAT  IS  FAIR 

nized  to  be  a  proper,  if  desirable,  public 
function  —  for  exactly  the  same  reason 
that  men  go  into  any  other  business, 
namely:  to  make  money.  Perhaps  this 
is  not  the  most  laudable  ambition  and  it 
may  be  that  it  is  not  to  be  compared 
favorably  with  the  ambition  of  the  scholar 
in  pure  science,  whose  ambition  is  to  dis- 
cover something  new  and  valuable  to  the 
world,  but  it  is  an  ambition  regarded  as 
worthy  by  most  men,  possibly  because 
it  is  the  principal  ambition  of  most  men. 
And  it  seems  fair  to  say  that  the  business 
man,  who  has  reached  the  point  where 
he  is  satisfied  with  simple  interest  on  his 
money  has  passed  the  period  of  greatest 
usefulness  to  his  community  and  to  the 
world  unless  he  devotes  his  life  to  gra- 
tuitous public  service;  he  has  lost  his 
ambition  to  create  wealth  (it  is  thought 
that  the  successful  distributor  of  wealth 
is  almost  certain  to  be  also  a  creator  of 
wealth),  he  has  lost  a  human  quality 
most  essential  to  the  material  progress  of 
the  world.  Let  it  be  granted  at  once 
that  material  progress  is  not  more  im- 


WHAT  IS  FAIR  RETURN  95 

portant  than  spiritual  progress  if  indeed 
it  is  as  important,  but,  also,  let  it  be  rec- 
ognized that  material  progress  is  essen- 
tial whichever  may  be  deemed  the  more 
desirable. 

If  then  we  prefer  to  have  men  of  am- 
bition and  courage  undertake  to  serve  us 
in  certain  ways  rather  than  to  serve  our- 
selves; to  provide  our  water  supplies, 
our  light,  heat,  and  power,  and  our  trans- 
portation facilities;  must  we  not  expect 
to  permit  them  to  earn  at  least  as  much 
as  men  of  average  success  earn  in  other 
businesses  of  equal  risk  and  magnitude? 
It  is  recognized  that  "  equal  risk  and  mag- 
nitude "  is  a  well-sounding  phrase,  an  at- 
tempt to  become  acquainted  with  which 
will  develop  difficulties.  On  the  other 
hand,  if  we  give  these  men  of  ambition 
and  courage  the  practically  exclusive 
privilege  of  supplying  us  with  certain 
necessaries  of  life,  may  we  not  say  to 
them,  "You  must  deal  fairly  with  us. 
You  must  charge  us  no  more  than  the 
service  is  worth,  and  this  must  be  deter- 
mined by  its  cost  to  you,  because  its  cost 


96  WHAT  IS  FAIR 

to  you  may  be  considered  to  be  what  it 
would  cost  us  to  serve  ourselves.  To  this 
cost  to  you  we  shall  expect  to  add  a  good 
profit  to  pay  you  for  relieving  us  of  the 
burden  of  serving  ourselves  but  we  shall 
look  to  you  to  see  that  this  profit  is  not 
more  than  successful  men  in  private  busi- 
ness of  equal  risk  and  investment  expect 
to  earn.  Come,  let  us  agree  as  to  what 
this  shall  be  and  how  we  shall  treat 
and  share  from  time  to  time  in  the  bene- 
ficial results  of  advances  in  the  art  of 
furnishing  the  service  you  propose  to 
furnish. " 

It  may  be  that  the  fair  return  will  "de- 
pend on  the  nature  of  the  business.  The 
furnishing  of  an  absolute  necessity,  like 
water,  by  a  monopoly  company  should 
call  for  a  less  rate  of  return  than  the 
furnishing  of  a  luxury  like  gas  or  elec- 
tricity for  two  reasons: 

1.  A  sociological  reason  —  because  ab- 
solute necessities  should  be  supplied  al- 
ways at  the  lowest  possible  cost. 

2.  A  business  or  economic  reason  — 
because  there  is  less  risk  in  developing  a 


WHAT  IS  FAIR  RETURN  97 

property  to  supply  an  absolute  necessity, 
for  which  there  is  no  practicable  substi- 
tute, than  in  developing  a  property  to 
supply  gas  or  electricity,  either  of  which 
is  always  in  partial  competition  with  the 
other  and  both  in  partial  competition 
with  oil,  and  in  potential  competition 
with  new  developments.  To  be  sure  as 
time  goes  on  gas  and  electricity  seem  to 
tend  to  become  necessities,  but  there  is 
always  much  more  to  be  done  to  develop 
this  condition  than  to  develop  the  neces- 
sity for  a  pure  water  supply,  although 
the  possibility  in  the  development  of  de- 
mand is  much  more  unlimited  than  is 
that  of  developing  a  demand  for  water. 
Though  the  demand  for  water  may  be 
limited  yet  water  will  always  be  needed, 
it  will  never  go  out  of  style  or  be  super- 
seded by  something  better.  Gas  prop- 
erties have  already  suffered  by  the  in- 
troduction of  electricity,  and  the  art  of 
electric  lighting  and  power  development 
and  transmission  is  advancing  so  rapidly 
that  new  machinery  and  appliances  of 
today  must  be  discarded  tomorrow,  and 


08  WHAT  IS  FAIR 

not  even  large  functional  depreciation 
allowances  will  offset  the  considerable 
risk  that  must  be  recognized  as  a  reason 
for  allowing  a  high  rate  of  return. 

Again  different  businesses  require  dif- 
fering ratios  of  capital  to  annual  volume 
of  business  done.  The  successful  private 
mercantile  business  has  as  a  rule  gross 
annual  receipts  far  in  excess  of  its  in- 
vested capital  so  that  2  per  cent  of  the 
gross  annual  receipts  may  mean  from  6 
to  20  per  cent  of  the  invested  capital, 
while  in  a  railroad  business  one  finds  ex- 
actly the  opposite  condition.  The  in- 
vested capital  in  such  business  is  always 
larger  than  the  gross  annual  receipts,  so 
that  as  an  average  for  the  United  States, 
perhaps  it  is  fair  to  say  that  a  profit  of 
20  per  cent  of  the  gross  annual  receipts 
will  mean  not  more  than  5  per  cent  and 
perhaps  less  on  the  honestly  and  reason- 
ably invested  capital,  so  that  a  relatively 
large  rate  of  return  measured  as  a  per- 
centage of  business  done  must  be  allowed 
such  enterprises  in  order  to  make  the 
return  measured  as  a  percentage  of  in- 


WHAT  IS  FAIR  RETURN  99 

vested  capital  compare  favorably  with 
the  returns  of  purely  private  enterprises. 

The  legal  rate  of  interest  in  a  given 
state  or  country  may  influence  the  con- 
clusion as  to  fair  rate  of  return.  If  the 
legal  rate  has  been  determined  by  the 
people  to  be  6  per  cent  and  not  more 
than,  say,  8  per  cent  may  be  charged 
without  involving  the  charge  of  usury, 
then  it  would  seem  to  be  clear  that  6  per 
cent,  or  even  8  per  cent,  is  not  enough  to 
warrant  a  company  in  investing  its  money 
in  a  business  that  requires  effort  and  the 
taking  of  certain  risks,  from  both  of 
which  the  money  lender  is  free,  when  he 
lends  on  good  security. 

Again,  should  public  utility  business 
share  hi  general  prosperity  and  depres- 
sion, or  should  it  earn  steadily  at  a  given 
rate?  Here  the  nature  of  the  business 
will  control  somewhat.  A  water  supply- 
ing corporation  will  feel  changes  in  busi- 
ness activity  perhaps  less  than  any  other 
form  of  public  service;  railroads  and 
power  supplying  concerns  will  of  neces- 
sity feel  business  changes  in  larger  de- 


100  WHAT  IS  FAIR 

gree.  Their  rates  cannot  continually  be 
changed  by  publishing  discount  sheets 
affecting  a  base  price,  and  hence  as  a 
practical  necessity  they  must  earn  more 
during  prosperous  times  than  during  dull 
times.  It  is  very  desirable  that  the  se- 
curities of  these  corporations  owned  at 
large  by  the  general  public  shall  remain 
fairly  constant  in  value,  changing  only 
slowly,  and  hence  the  fair  rate  of  return 
should  lie  somewhere  between  a  proper 
upper  limit  for  prosperous  times  and  a 
proper  lower  limit  for  dull  times,  if  such 
limits  can  be  fixed. 

Most  of  the  foregoing  matters  are  of 
concern  to  private  business  as  well  as  to 
privately  owned  public  utilities.  The 
two  are  unlike  only  in  the  greater  degree 
of  control  exercised  by  government  over 
public  utilities  and  the  fact  that  these  are 
as  a  rule  more  nearly  monopolistic  in 
character  than  private  business,  which 
though  not  always  so,  is  more  often  en- 
tirely competitive.  Because  of  the  mo- 
nopolistic feature  of  public  utility  serv- 
ice, a  feature  in  some  cases  less  existent 


WHAT  I-    FAIR  RETURN  101 

than  is  often  supposed,  such  enterprises 
should  be  subject  to  many  more  restric- 
tions than  private  business  and  they 
should  be  limited  to  a  moderate  rate  of 
return  on  their  invested  capital,  some  per- 
sons believing  6  per  cent  to  be  sufficient. 
The  considerations  thus  far  developed 
ought  to  indicate  that  no  uniform  rate 
of  return  can  be  fixed  that  will  be  fair  to 
all  utilities;  that  we  cannot  expect  busi- 
ness men  to  go  into  public  business  with 
an  expectation  of  earning  less  than  they 
could  earn  with  any  success  in  other  enter- 
prises of  equal  risk  and  magnitude,  because 
they  go  into  public  business  for  the  same 
reason  that  they  go  into  private  business 
-  to  make  money,  and  until  private  busi- 
ness is  limited  by  law,  there  would  seem  to 
be  no  good  reason  to  limit  the  earnings  of 
privately  owned  public  utilities  to  less  than 
the  return  of  the  average  successful  pri- 
vate business  of  equal  risk  and  magnitude. 
No  definite  percentage  can  be  fixed  as 
measuring  this  return,  but  that  it  is  more 
than  the  5  or  6  per  cent  that  some  would 
fix  as  the  limit,  a  glance  at  a  purely  hypo- 


102  WHAT  IS  ?AIR 

thetical  but  entirely  reasonable  example 
will  serve  to  show. 

The  banking  business,  while  competi- 
tive and  complex  in  its  details,  is  in  gen- 
eral theory  one  of  the  simplest  busi- 
nesses to  reason  about  and  being  pretty 
well  controlled  by  law  furnishes  a  fairly 
good  example  from  which  to  begin  reason- 
ing with  respect  to  other  business.  It 
involves  some  risks  but  when  well  man- 
aged is  perhaps  reasonably  free  from  most 
of  the  risks  attending  many  other  busi- 
nesses. The  banking  company  has  capi- 
tal invested,  and  generally  the  law  makes 
it  necessary  that  its  capital  shall  be  all 
actual,  that  if  $100,000  of  capital  stock 
is  issued,  $100,000  of  cash  must  be  be- 
hind it  actually  paid  into  the  treasury 
of  the  company.  The  banking  company 
has  operating  expense  consisting  of 
rentals,  stationery,  printing,  advertising, 
wages,  and  other  incidentals,  and  interest 
paid  to  depositors,  really  lenders  to  the 
bank.  It  performs  service  for  its  deposi- 
tors, stores  their  money,  furnishes  them 
with  books,  checking  blanks,  etc.,  and 


WHAT  IS  FAIR  RETURN  103 

pays  out  their  money  on  their  order, 
keeping  track  of  receipts  and  payments. 
For  the  use  of  the  depositor's  money,  the 
company  pays  this  service  and  from 
nothing  to,  perhaps,  4  per  cent  interest. 
The  rate  depends  on  the  character  of  the 
deposits,  savings,  or  open  account  money, 
and  their  magnitude;  very  large  open 
accounts  receiving,  perhaps,  2  per  cent 
on  the  average  daily  balances,  small 
accounts  nothing. 

The  banking  company  lends  its  own 
and  its  depositor's  money  to  others  and 
charges  from  5  to  8  per  cent  or  more  de- 
pending on  the  size  of  the  loan,  the  nature 
of  the  security  furnished,  the  law  fixing 
the  maximum  rate,  the  demand  for 
money,  and  competition,  although  there 
is  little  variation  in  the  rate  due  to  com- 
petition. It  also  has  a  small  amount  of 
incidental  charges  for  commissions,  pro- 
tests, etc.  As  a  result  of  its  charges  and 
expenditures  the  company  may  clear 
from  1  to  2  per  cent  on  its  loans;  that 
is  to  say,  if  the  average  charges  are,  say, 
6  per  cent,  then  from  £  to  i  of  this,  or 


104  WHAT  IS  FAIR 

16f  to  33|  per  cent  of  its  charges,  or 
gross  business,  is  profit. 

If  a  banking  company  with  $100,000 
capital  has  loans  amounting  to  $1,000,000, 
which  is  a  not  uncommon  ratio,  and  its 
average  interest  charge  is  6  per  cent  yield- 
ing $60,000,  and  if  H  per  cent  on  the 
loans,  or  a  quarter  of  the  charge  is  profit, 
the  banking  company  earns  net  $15,000 
or  15  per  cent  on  its  invested  capital. 
This  is  not  at  all  an  unusual  or  peculiar 
result  of  the  operation  of  a  moderate 
banking  business  in  a  moderate  sized 
community.  If  the  loans  are  two  million 
dollars  with  the  same  ratio  of  expense 
and  profit,  the  net  earnings  will  be  30 
per  cent  on  the  capital,  while  if  the  loans 
are  only  half  or  $500,000,  the  net  earn- 
ings will  be  but  7|  per  cent  on  the  capi- 
tal. Of  these  two  latter  conditions  the 
first  is  rare  and  represents  unusually  prof- 
itable business,  and  the  second,  though 
not  to  be  called  rare,  represents  somewhat 
less  than  an  average  success  in  banking. 
It  will  be  noted  here  that  the  gross  busi- 
ness done  —  the  gross  charges  for  serv- 


WHAT  IS  FAIR  RETURN  105 

ice  —  may  be  either  less  or  more  than 
the  capital  invested.  Generally  they  will 
be  less.  In  the  normal  case  cited,  per- 
haps 5  per  cent  may  be  called  interest, 
or  money  wage,  and  10  per  cent  profit, 
or  service  wage. 

If  the  foregoing  is  fairly  representa- 
tive of  the  conservative  business  of 
banking  —  a  business  hedged  by  regula- 
tory statutes,  and  such  results  are  rec- 
ognized as  fair  and  reasonable,  does  it 
not  appear  that  we  should  hesitate  to 
limit  any  public  utility  to  a  5  or  6  per 
cent  return  on  the  capital  reasonably 
invested? 

Another  consideration  may  be  sugges- 
tive. About  the  best  security  offered 
money  lenders  is  real  estate.  Of  this, 
farm  land  is  considered  better  than  ur- 
ban property,  some  banking  laws  permit- 
ting a  larger  percentage  of  bank  capital 
to  be  loaned  to  one  person  on  farm  lands 
than  on  city  property.  But  these  laws 
usually  provide  that  not  more  than  half 
of  the  value  of  a  given  property  may  be 
loaned  on  the  property  as  security. 


106  WHAT  IS  FAIR 

Quite  generally,  outside  of  banking  prac- 
tice, real  estate  loans  are  limited  to  half 
the  value  of  the  property  offered  as  se- 
curity. Public  utility  properties  are  built 
on  borrowed  money,  for  whether,  as  is 
frequent,  they  are  built  on  the  proceeds 
of  bonds  sold,  or  on  stock  sales,  or  both, 
the  money  is  that  of  individuals  loaned 
to  the  company.  The  security  is  in 
general  not  a  value  represented  by  the 
cost  of  the  property,  because  the  prop- 
erty once  built  has  nothing  but  salvage 
value  except  as  it  has  earning  capacity. 
Its  earning  capacity  is  its  principal  ele- 
ment of  value  and  this  is,  therefore,  the 
principal  element  of  value  that  stands 
as  security  for  the  money  loaned.  In 
practically  no  case  of  a  new  company 
would  this  security  be  as  good  as  real 
estate  security.  There  is  more  of  the 
element  of  chance  involved.  Therefore, 
it  would  seem  that  the  ratio  of  apparent 
security  to  loan  should  be  greater  than 
is  customary  in  real  estate  loans.  This 
means  that  the  expected  earning  capac- 
ity should  be  at  least,  and  usually  is 


WHAT  IS  FAIR  RETURN  107 

more  than,  twice  the  fixed  charge  or  in- 
terest on  the  money  invested.  As  a 
general  thing  corporations  have  to  pay, 
including  the  effect  of  discounts,  from  6 
to  10  per  cent  for  the  money  they  bor- 
row in  the  beginning,  less  after  they  are 
well  established. 

Hence  it  would  appear  that  on  the 
primary  investment  a  total  expected  re- 
turn of  from  12  to  20  per  cent  will  be 
necessary  to  attract  conservative  capital 
to  such  enterprises.  Approximately  half 
of  this  represents  interest,  wage  of  money 
invested,  and  the  rest  is  profit,  or  wage 
of  service. 

Now  without  question  when  business 
properties,  any  of  them,  purely  private 
or  privately  owned  public  utilities,  are 
firmly  established  and  earning,  say,  15 
per  cent  on  the  outstanding  capital,  there 
will  be  those  who  will  be  glad  to  buy  the 
securities  on  a  5  per  cent  basis,  and  the 
market  price  of  the  stock  may  be  300,  or 
three  times  its  par  value.  The  stock 
may  then  be  increased  —  watered  as  it 
is  sometimes  called  —  to  three  times  the 


108  WHAT  IS  FAIR 

original  amount,  and  the  increase  dis- 
tributed gratis  to  the  stockholders  of 
record.  Other  things  may  be  done  that 
are  less  defensible.  It  has  been  not  un- 
common for  public  utility  corporations 
to  keep  their  evidences  of  capital,  bonds 
and  stocks,  at  such  an  amount  that  the 
return  should  appear  to  be  not  more  than 
from  5  to  8  per  cent,  largely  because  of 
the  fear  that  the  public  noting  larger 
returns  would  take  action  to  reduce  the 
earnings.  This  would  be  made  unneces- 
sary by  a  reasonable  attitude  of  the  public 
toward  its  service  corporations;  a  real- 
ization that  those  engaged  in  public  util- 
ity work  are  not  public  agents  entitled  to 
a  wage  only  and  guaranteed  that  wage,  but 
that  they  are  business  men  engaging  in  a 
business  for  the  same  reason  that  other 
men  engage  in  other  business  with  no 
guarantee  against  failure,  and  that  sub- 
ject to  certain  limitations  of  fair  dealing 
when  supplying  common  necessities,  or 
doing  a  monopoly  business,  they  are  en- 
titled to  make  their  talents  earn  other 
talents  just  as  other  business  men,  praised 


WHAT  IS  FAIR  RETURN  109 

for  their  foresight,  judgment,  and  ability, 
make  their  talents  earn  other  talents. 

It  has  been  said  that  when  government 
gives  a  monopoly  franchise,  it  guarantees 
a  fair  return  because  the  monopoly  may 
charge  enough  to  secure  it.  If  one  rate 
will  not  do  this,  another  will.  Perhaps 
this  would  be  a  nice  question  of  econom- 
ics to  discuss,  were  it  not  that  it  is  pretty 
well  settled  by  the  fact  that  there  have 
been  numerous  failures  of  first  efforts  in 
developing  public  utility  properties  and 
not  all  of  them  chargeable  to  improper 
financial  manipulation,  or  defective  ac- 
counting. 

Must  not  the  conclusion  of  the  matter 
be  that  the  "  fair  return  "  on  the  "fair 
value  "  of  a  public  utility  property,  that 
the  courts  have  talked  about  so  much 
and  have  judged  to  be  the  right  of  every 
public  utility  corporation  to  earn,  means 
any  return  the  corporation  can  earn  by 
honorable  methods  when  operating  freely 
without  rate  regulation,  so  long  as  it  does 
not  exceed  on  the  reasonable  investment 
the  rate  of  return  expected  by  the  man 


110  WHAT  IS  FAIR 

or  corporation  of  average  success  in  other 
business  of  equal  risk  and  magnitude. 
And  may  not  the  rate  exceed  this  aver- 
age successful  rate  if  thereby  incentive 
is  given  to  develop  economies  in  which 
the  public  may  share? 

Is  there  any  other  fair  conclusion  to 
reach  so  long  as  there  are  no  guaranteed 
minimum  earnings?  As  the  business  be- 
comes established  and  safe,  the  risk  is 
reduced  and  earnings  on  later  invest- 
ments should  be  less  than  on  the  original 
investment,  but  there  seems  to  be  no 
good  reason  for  limiting  the  rate  of  re- 
turn on  the  investment  made  up  to  a 
given  time  of  inquiry,  to  less  than  the 
company  has  been  able  to  develop  by 
honorable  means. 

It  is  not  intended  to  suggest  that  when 
a  public  utility  business  is  established  on 
a  15  per  cent  dividend  basis,  for  instance, 
and  is  sold  to  others  on  a  5  per  cent  in- 
vestment basis,  or  has  its  stock  increased 
and  distributed  gratis  to  its  owners  to 
capitalize  the  earning  capacity,  it  is  still 
entitled  to  earn  15  per  cent  if  it  can  on 


WHAT  IS  FAIR  RETURN  111 

the  new  capitalization,  which  is  not  the 
reasonable  cost.  The  reason  is,  of  course, 
that  the  risk  that  pertained  to  the  origi- 
nal investment  does  not  pertain  to  the 
established  property;  otherwise  it  could 
not  be  sold  on  a  5  per  cent  investment 
basis;  and  by  so  selling  it  or  by  distrib- 
uting additional  stock  gratis  to  the  stock- 
holders, those  who  assumed  the  risk  of 
the  venture  have  capitalized  their  full 
reasonably  allowable  risk  profits  and  are 
not  in  fairness  entitled  to  earn  risk  profits 
on  the  new  capitalization. 

Their  greatest  risk  may  now  be  the 
risk  of  public  regulation.  A  single  in- 
stance may  illustrate.  A  certain  corpo- 
ration after  many  vicissitudes  finally  be- 
came prosperous  and  was  earning  about 
13  per  cent  on  the  reasonable  cost  as 
estimated  by  a  public  regulating  body 
and  was  slowly  but  steadily  increasing 
its  earning  capacity.  The  regulating  body 
after  discussing  rates  of  return  necessary 
to  induce  capital  to  enter  public  service, 
recognizing  that  there  were  risks  involved 
and  quite  naively  admitting  that  the  risk 


112  WHAT  IS  FAIR 

of  public  regulation  was  one  of  these,  de- 
termined a  7  per  cent  return  to  be  suffi- 
cient for  the  class  of  service  under  con- 
sideration, and  proceeded  to  establish 
rates  for  the  corporation  that  would  prac- 
tically cut  its  earning  power  in  two,  and 
would  prohibit  further  increase.  Assum- 
ing that  the  estimated  reasonable  cost 
was  properly  equivalent  to  the  invest- 
ment, the  principles  of  fair  dealing  in- 
tended to  be  developed  in  this  discussion 
were  violated  by  the  action  of  the  regu- 
lating body  of  the  foregoing  example. 

It  does  not  seem  necessary  to  intro- 
duce the  innocent  stock  purchaser  argu- 
ment to  sustain  this  point,  but  it  may  be 
introduced  to  complete  the  argument. 
Let  it  be  supposed  that  certain  persons 
—  it  is  not  necessary  to  call  them  widows 
or  orphans  to  add  the  element  of  senti- 
ment to  strengthen  the  argument  —  have 
invested  in  the  stock  of  the  corporation 
on  a  5  or  6  per  cent  or  even  on  the  7  per 
cent  basis  deemed  fair  by  the  regulating 
body.  What  happens  to  the  investment 
of  these  persons?  Their  investment  is 


WHAT  IS  FAIR  RETURN  113 

immediately  reduced  to  a  2|  to  3|  per 
cent  investment,  and  their  very  living 
may  be  in  danger.  True,  they  might 
have  invested  in  safer  securities  yielding 
5  or  6  per  cent,  free  from  the  vagaries  of 
public  regulation,  which  was  one  of  the 
risks  they  assumed  when  making  their 
purchases  of  the  public  utility  stock,  but 
it  is  submitted  without  fear  of  contra- 
diction that  the  risk  of  public  regulation 
should  not  be  the  chief  risk  of  an  hon- 
estly and  honorably  conducted  public 
business  yielding  no  more  than  a  success- 
ful business  man's  profit  on  the  reason- 
able investment  necessary  to  create  the 
property. 

The    conclusion   from   the    considera- 
tions of  this  chapter  are: 

1.  That  the  fair  return  to   a  public 
utility  corporation  is  any  return  it  is  able 
to  earn  by  fair  and  honorable  dealing  so 
long  as  this  is  not  more  than  successful 
men  in  other  business  of  equal  risk  and 
magnitude  earn  on  honestly  and  reason- 
ably invested  capital. 

2.  That  the  age  and  firmness  of  estab- 


114  WHAT  IS  FAIR 

lishment  of  the  business  may  be  consid- 
ered in  determining  the  risk;  but  — 

3.  That  any  earning  capacity  a  corpo- 
ration has  developed  by  honorable  means 
and  public  permission,  expressed  or  tacit, 
at  the  time  it  is  first  under  investigation, 
except  from  rates  tentatively  permitted 
in  the  course  of  regulation,  is  property  not 
to  be  taken  away  without  compensation 
except  as  definitely  provided  for  in  the 
charter  or  franchise. 

4.  That  because  their  securities  are  so 
largely  held  as  trust  funds  or  widely  dis- 
tributed among  the  people  as  permanent 
investment,  utilities  subject  to  large  fluc- 
tuations   in    earnings    with    changes    in 
business   conditions  must  share   in   the 
general  prosperity  of  good  times  as  well 
as  in  the  leanness  of  dull  times  in  order 
that  their  return  may  be  fairly  constant. 

5.  That  public  regulation  should  not 
be  the  greatest  risk  of  any  honorably  con- 
ducted business. 

6.  That     public     utility  corporations 
should  be  content  with  returns  equiva- 
lent to  those  of  average  success  in  other 


WHAT  IS  FAIR  RETURN  115 

business  of  equal  risk  and  magnitude, 
and  except  as  they  should  be  allowed 
to  continue  any  return  they  may  have 
acquired  at  the  time  of  first  investiga- 
tion, they  should  be  limited  by  public 
control  to  such  returns  as  mark  average 
success  in  other  lines  of  equal  risk  and 
magnitude. 

7.  That  in  general  a  fair  return  on  the 
primary    investment    in    new    concerns 
when  measured  as  a  percentage  on  the 
reasonable  actual  cost  of  a  property  and 
including  interest  and  profit  is  from  two 
to  three  and  one-half  times  the  going  rate 
of   interest    on    commercial    loans;     the 
lesser  rate  for  properties  of  such  risk  and 
monopoly  character  as  water  works  built 
under  favorable  conditions;    the  greater 
for  properties  of  such  risk  as  railroads 
built  through  new  territory;    fair  return 
to  properties  of  intermediate  risk  falling 
between    the    higher    and    lower    limits 
named.     The  definite  figures  are  given 
somewhat  hesitatingly  and  as  suggestive 
rather  than  as  finally  determined. 

8.  That  in  general  for  successful  going 


116  WHAT  IS  FAIR 

properties  of  any  kind,  minimum  fair  re- 
turn on  new  capital  for  ordinary  better- 
ments and  additions  will  be  from  once  and 
one-half  to  twice,  the  rate  at  which  the 
company  owner  can  borrow  money;  while 
for  large  extensions  equivalent  to  new 
properties  the  return  should  be  as  for 
primary  investment  in  new  concerns. 

9.  That  after  the  minimum  fair  return 
has  been  reached,  in  order  to  encourage 
wide  and  economic  service,  the  profit  or 
service  wage,  measured  as  a  percentage  of 
capital,  should  grow  with  growth  of  serv- 
ice and  reduction  in  rates;  the  interest 
or  money  wage  remaining  at  a  constant 
rate  as  long  as  the  borrowing  rate  re- 
mains constant  and  changing  only  with 
that  rate.     The  profit  rate,  expressed  as 
a  percentage  of  operating  cost  or  income, 
should  grow  less  with  increase  of  magni- 
tude of  business. 

10.  That  under  continuous  regulation 
the  equation  given  below  may  represent 
a  fair  return  over  and  above  all  expenses. 
In  this  equation  7  is  the  total  invested 
capital,  C  is  the  annual  operating  cost 


WHAT  IS  FAIR  RETURN  117 

including  all  items  except  fixed  charges, 
and  r  is  the  rate  at  which  the  corporation 
can  borrow  money. 

Fair  return  =  rl  + 


The  application  of  this  equation  pays  in- 
terest, the  wage  of  money,  at  the  rate  r  on 
all  capital  whether  represented  by  bonds 
or  stock,  and  a  profit  rate  for  service  that 
grows  less  as  the  business  (cost)  is  larger, 
though  the  gross  money  profit  grows  with 
the  growth  of  business. 

If  r  is  5%,  the  rate  on  C  is  about  16% 
when  the  business  (cost)  is  about  $10,000, 
and  5%  when  the  business  is  $100,000,000. 
The  expression  is  such  that  extension  of 
business  on  a  given  capital  is  encouraged, 
and  as  in  other  private  enterprises  it  will 
be  found  profitable  to  do  business  with 
borrowed  capital  so  far  as  this  may  be 
safe.  Public  control  must  be  exercised 
to  see  that  operating  costs  are  not 
inflated. 

Again  definite  figures  are  given  with 
diffidence.  The  coefficient  10  and  the 
exponent  -J  of  the  second  term  may  be 


118  WHAT  IS  FAIR 

subjects  for  discussion  and  gross  income 
may  be  used  in  place  of  operating  cost. 
The  principle  seeming  to  accord  with 
commercial  practice  is  thought  to  be 
sound. 


CHAPTER  V 
VALUATION 

Purpose  of  Discussion.  -  -  The  art  of 
valuing  public  utility  properties  is  by  no 
means  as  yet  an  art  with  fixed  principles. 
Engineers,  economists,  and  jurists  differ 
one  group  with  another  and  as  individ- 
uals within  groups  concerning  proper  pro- 
cedure in  determining  value  and  even  as 
to  what  constitutes  value.  It  is  the  pur- 
pose of  this  discussion  to  set  forth  cer- 
tain views  concerning  what  constitutes 
the  value  of  a  public  utility  property, 
the  principles  to  be  observed  in  estimat- 
ing value,  and  the  principles  to  be  ob- 
served in  estimating  certain  other  basic 
quantities  commonly,  but,  perhaps,  un- 
wisely called  "  value  "  for  one  purpose 
or  another,  as  "Value  for  Rate  Making," 
"Value  for  Capitalization,"  "Value  for 
Taxation,"  etc.,  and  to  mention  some  of 
the  many  perplexing  problems  involved. 

119 


120  WHAT  IS  FAIR 

For  definiteness  of  statement  and  illus- 
tration a  railroad  property  will  be  more 
particularly  considered. 

Depending  for  conviction  on  the  seem- 
ing fairness  of  the  positions  taken,  little 
argument  will  be  used,  but  the  rather 
will  didactic  statements  be  made  for  the 
most  part,  with  occasional  brief  state- 
ment of  reasons,  where  this  seems  neces- 
sary. Arguments  concerning  most  of  the 
points  raised  —  not  always  by  any  means 
supporting  the  views  now  to  be  set  forth 
-  may  be  found  in  a  considerable  recent 
literature  on  the  general  subject,  a  quite 
complete  bibliography  of  which  brought 
down  to  July,  1913,  has  been  published 
by  the  American  Society  of  Civil  Engi- 
neers, and  after  being  extended  to  De- 
cember, 1915,  has  been  again  published 
by  the  American  Electric  Railway  Asso- 
ciation. No  extended  bibliography  will 
be  given  here,  but  attention  may  be 
called  to  the  work  of  Robert  H.  Whitten 
in  two  volumes,  which,  without  itself  pre- 
senting generally  positive  conclusions  of 
its  author,  does  present  the  essentials  of 


VALUATION  121 

most  of  the  court  and  commission  de- 
cisions that  have  been  made  on  ques- 
tioned points;  and  to  the  report  of  the 
special  committee  of  the  American  So- 
ciety of  Civil  Engineers  appointed  to 
study  and  report  on  this  general  subject. 
A  progress  report  was  made  in  1913  and 
caused  much  discussion.  A  final  report 
has  been  made  and  is  published  in  the 
December,  1916,  Proceedings  of  the  So- 
ciety. Since  then  a  work  by  C.  E. 
Grunsky  "Valuation,  Depreciation  and 
the  Rate  Base,"  and  one  by  Harry  Barker 
"Public  Utility  Rates,"  have  appeared. 

VALUE 

But  One  Normal  Value.  —  There  is 
but  one  normal  value  of  a  commercial 
enterprise  owned  and  operated  for  gain. 
That  value  is  what  is  sometimes  called 
the  exchange  value  or  the  market  value, 
and  is  measured  by  the  sum  that  will  be 
agreed  to  in  a  sale  by  a  willing,  intelli- 
gent, and  solvent  owner  to  a  willing,  intel- 
ligent, and  solvent  buyer.  It  is  not  the 
price  that  may  result  from  a  forced  sale, 


122  WHAT  IS  FAIR 

or  a  sale  at  auction.  The  sum  that 
measures  the  exchange  value  depends 
most  largely  on  the  dependable  net  earn- 
ings. The  dependable  net  earnings  de- 
pend not  only  on  the  volume  of  business 
done,  and  the  efficiency  with  which  it  is 
done,  but,  also,  on  the  character  of  the 
regulation,  if  there  be  regulation,  as  there 
now  is  throughout  the  United  States. 
It  depends  in  part  on  the  rate  allowed 
by  the  regulating  body  to  be  charged  for 
service  and  hence  the  courts  have  said 
that  value  for  rate  making,  that  is  the 
sum  to  be  used  as  a  basis  for  determin- 
ing the  fair  rate  of  return  to  which  the 
courts  say  a  public  utility  is  entitled, 
cannot  be  the  value  based  on  dependable 
net  earnings  since  these  earnings  are  de- 
pendent on  the  rates  and  the  result  would 
be  to  reason  in  a  circumference.  This 
point  will  be  discussed  farther  on.  The 
normal  value,  then,  of  a  railroad  prop- 
erty may  be  said  fairly  to  be  the  de- 
pendable net  earnings  capitalized  at  an 
agreed  going  rate  of  interest,  less  any 
cost  necessary  to  restore  the  physical 


VALUATION  123 

property  to  normal  working  condition  if 
it  is  found  in  any  particular  to  be  below 
such  condition  at  the  time  of  valuation. 

There  are  exceptions  to  this  rule  for 
value.  The  value  of  a  particular  prop- 
erty to  another  property  proposing  to 
purchase  may  be  more  than  its  capital- 
ized dependable  net  earnings  because  of 
the  additional  earnings  it  will  bring  to 
the  purchasing  property,  as,  for  instance, 
a  feeder  line  unprofitable  in  itself  but  of 
value  to  the  purchasing  line  because  of 
the  addition  of  traffic  at  paying  rates  to 
the  purchasing  line.  In  such  a  case  it  is 
total  dependable  net  earnings  resulting 
to  the  purchasing  property  by  reason  of 
the  purchase  that  should  be  used  as  the 
basis  for  determining  the  value  of  the 
feeder  to  the  main  line.  The  price 
agreed  upon  in  a  sale  will  probably  be  a 
figure  somewhere  between  the  value  of 
the  line  as  an  independent  property  and 
its  value  to  the  purchasing  line. 

Branch  lines  of  main  lines  are  often 
built  and  owned  by  separate  corporations 
and  then  leased  to  the  parent  company 


124  WHAT  IS  FAIR 

or  controlled  by  the  parent  company 
through  some  legally  proper  process  which 
leaves  the  branch  line  a  separate  property 
in  law  although  in  effect  a  part  of  the 
property  of  the  parent  company.  In 
connection  with  a  public  question,  as  a 
matter  of  equity,  the  two  properties  gen- 
erally should  be  considered  together  when 
finding  the  value  of  either  one,  although 
in  law  they  are  separate  properties.  If 
considered  separately  the  branch  line 
might  show  a  very  small  value,  possibly 
no  more  than  salvage  value,  and  the 
main  property  a  value  larger  than  would 
appear  without  the  effect  of  the  control 
of  the  branch  line.  This  might  lead  to 
an  inequitable  solution  of  the  question 
at  issue. 

A  new  property  just  about  to  operate 
or  but  recently  opened  has  no  depend- 
able net  earnings,  but  normal  value  here 
will  be  the  capitalized  estimated  net  earn- 
ings, although  it  would  appear  that  if  the 
property  has  been  well  planned,  it  will 
be  worth  at  least  what  it  cost,  and  it  may 
be  that  cost  in  this  case  will  be  a  better 


VALUATION  125 

measure  of  value  than  capitalized  esti- 
mated net  earnings.  This  will  depend 
on  the  judgment  of  owner  and  prospec- 
tive purchaser  and  for  such  a  case  no 
set  rule  can  be  formulated;  one  man 
may  see  possibilities  that  another  does 
not. 

Uncertainty  concerning  the  future  of 
properties  created  and  existing  under 
short  term  franchises  may  require  a 
modification  of  capitalized  net  earnings 
when  finding  the  normal  value.  Public 
utility  properties  are  generally  permanent 
properties;  few  are  ever  discontinued; 
once  created,  the  service  rendered  be- 
comes a  necessity,  and  at  the  expiration 
of  the  franchise  the  particular  owners 
must  secure  a  new  franchise,  or  dispose 
of  the  property  to  another  company  own- 
ing a  franchise,  or  to  the  public.  Pos- 
sible changes  in  the  terms  of  a  new  fran- 
chise, making  it  less  or  more  favorable 
to  the  operating  company  than  the  old 
franchise,  or  probability  of  a  favorable 
or  unfavorable  sale  of  the  property  at  the 
expiration  of  the  franchise  will  be  of  in- 


126  WHAT  IS  FAIR 

fluence  in  fixing  the  normal  value  of  the 
property.  These  things  affect  the  de- 
pendableness  of  prospective  earnings,  and 
capitalized  present  net  earnings  will  cer- 
tainly be  discounted  if  the  future  appears 
to  be  less  favorable  than  the  present. 
It  must  be  distinctly  borne  in  mind  that 
neither  a  rating  case  nor  "fair  value  "  for 
rate  regulation  is  being  considered  now, 
but  simply  value,  which  for  any  perma- 
nent business  property  at  any  time  can 
have  for  its  basis  nothing  but  earning 
capacity  present  and  prospective. 

The  value  of  a  railroad  is  not  constant. 
It  rises  and  falls  inversely  with  the  value 
of  money  and  this  may  be  temporarily 
affected  by  many  things  other  than  sup- 
ply and  demand;  it  rises  and  falls  with 
changes  in  men's  attitudes  and  whims, 
regardless  of  earning  capacity;  it  changes 
with  the  changes  in  the  public's  ideas  of 
regulation;  and  it  changes  with  changes 
in  business  conditions.  But  at  any  given 
time  if  dependable  net  earnings  can  be 
fairly  well  determined  or  estimated  for  a 
given  independent  whole  property  for  a 


VALUATION  127 

little  time  in  advance  of  the  date  of  val- 
uation, those  earnings  furnish  the  best 
possible  basis  for  estimating  the  normal 
value  of  the  property  at  the  date  of 
valuation. 

Almost  every  day  small  independent 
light  and  power  properties  are  being  ab- 
sorbed by  larger  corporations  controlling 
the  plants  of  a  number  of  cities,  and  buy- 
ing more  with  a  view  to  operating  a  num- 
ber of  plants  from  a  single  central  station 
and  so  affecting  certain  economies  while 
building  up  a  large  business.  Valuing 
these  small  plants  has  become  the  prin- 
cipal business  of  some  engineers  and  they 
generally  value  on  a  basis  of  cost  of  re- 
production less  depreciation  modified  by 
a  consideration  of  probable  net  earnings. 
Although  these  plants  have  limited  fran- 
chises, the  effect  of  the  consideration  of 
net  earnings  is  practically  always  to  in- 
crease the  purchase  price  over  cost  of 
reproduction  less  depreciation  and,  in- 
deed, over  the  investment  that  the  owner 
has  made  in  the  plant.  Therefore  a  price 
is  usually  agreed  upon  which  is  some- 


128  WHAT  IS  FAIR 

where  between  capitalized  net  earnings 
less  depreciation  and  cost  of  reproduction 
less  depreciation.  The  value  as  shown 
by  the  trade  in  such  a  case  is  based  on 
neither  capitalized  net  earnings  nor  re- 
production cost,  but  both  are  considered 
in  arriving  at  a  final  compromise  price 
which  for  the  time  must  be  considered 
to  represent  the  value  of  the  property, 
although  it  is  not  the  normal  value. 
The  same  result  would  likely  occur  if  a 
powerful  corporation  should  attempt  to 
form  a  number  of  independent  small  rail- 
road properties  into  one  large  property. 
But  railroad  charters,  being  practically 
always  perpetual,  the  normal  value  of  the 
final  property  must  rest  on  its  earning 
capacity.  < 

Again  it  must  be  stated  that  no  ques- 
tion of  regulation  is  under  consideration 
-  simply  the  business  value  —  the  nor- 
mal value  of  a  business  property,  a  rail- 
road, is  being  considered. 

Professional  investors  in  railroad  secu- 
rities try  to  keep  track  of  the  physical 
condition  of  properties  in  which  they  are 


VALUATION  129 

interested  so  that  the  market  price  of 
securities  very  often,  perhaps  usually  in 
times  of  ordinary  business  activity,  ap- 
proaches quite  closely  to  the  exchange 
or  market  value  of  the  property.  But 
temporary  fluctuations  in  business  con- 
ditions and  occasional  neglect  of  main- 
tenance that  does  not  become  known 
immediately,  and  peculiar  stock  market 
manipulations,  as  well  as  unexplainable 
variations  in  men's  ideas,  make  the 
market  prices  of  securities  unreliable  as 
an  entirely  satisfactory  measure  of  nor- 
mal exchange  value. 

To  find  the  Value  of  a  Railroad  Prop- 
erty. -  -  The  normal  value  of  a  railroad 
property  being  its  capitalized  dependable 
net  earnings  less  depreciation,  the  pre- 
liminary steps  in  the  determination  of 
the  value  are  three,  namely: 

1.  To  determine  the  dependable  net 
earnings. 

2.  To  determine  the  proper  interest 
rate  for  capitalization. 

3.  To  examine  the  physical  property 
and  determine  the  extent  of  abnormal  de- 


130  WHAT  IS  FAIR 

cretion,  if  any,  and  estimate  the  sum 
necessary  to  make  this  good. 

The  first  and  third  steps  are  somewhat 
linked  together;  that  is  to  say,  the  de- 
pendable net  earnings  are  not  known 
until  it  is  known  whether  proper  ex- 
penditures for  upkeep  and  the  proper 
reservations  for  depreciating  items  have 
been  made. 

Earnings.  —  To  find  the  dependable 
net  earnings  the  records  of  earnings  and 
expense  must  be  consulted,  the  character 
of  the  expense  items  must  be  examined 
to  determine  whether  they  are  all  likely 
to  continue  or  to  be  lessened  or  increased 
in  the  future  or  under  a  proposed  new 
management;  and  the  relations  of  the 
property  and  public  must  be  considered 
to  try  to  estimate  whether  or  not  rates 
for  service  are  likely  to  be  modified,  or 
expense  increased  by  new  requirements 
of  operation.  Although  opinions  may 
differ  on  this  point,  it  is  thought  to  be 
fair  to  say  that  expenses  to  be  deducted 
from  earnings  do  not  include  fixed  charges 
because  these  represent  a  part  of  the  value 


VALUATION  131 

of  the  property.  If  examination  shows 
that  apparent  net  earnings  are  too  large 
because  the  Company  has  not  charged 
off  enough  for  depreciation,  or  has  not 
spent  enough  for  proper  maintenance  of 
the  normal  condition  of  the  property, 
proper  adjustments  must  be  made  to  de- 
termine the  real  from  the  apparent  net 
earnings.  The  examination  should  ex- 
tend over  a  number  of  years  in  order  that 
the  ups  and  downs  of  fat  and  lean  years 
may  have  their  effect  and  the  general 
tendency  of  net  earnings  whether  up- 
ward, downward,  or  stationary  may  be 
learned. 

Capitalizing  Rate.  --  Having  found  the 
sum  judged  to  be  the  normal  net  earning 
capacity  of  the  property,  a  rate  of  inter- 
est for  capitalizing  is  discussed  and 
chosen.  The  rate  is  not  the  allowable 
rate  of  return  under  regulation,  but 
rather  a  composite  rate  that  represents 
about  what  would  be  necessary  to  induce 
careful  investors  to  place  their  money  in 
the  enterprise.  If  the  property  is  an  old 
substantial  property  it  may  be  able  to 


132  WHAT  IS  FAIR 

borrow  money  on  mortgage,  i.e.,  sell 
bonds  —  at  4|  or  5  per  cent  or  even  less, 
but  its  stock  is  not  likely  to  sell  in  the 
market  below  a  5  per  cent  basis,  although 
this  will  depend  somewhat  on  the  condi- 
tion of  the  money  market,  and  it  may 
vary  a  fraction  of  a  per  cent  either  way. 
If  it  happen  that  the  bonds  of  the  com- 
pany are  held  on  a  4  per  cent  basis  in 
the  market  and  the  stock  on  a  5  per  cent 
basis,  and  that  there  are  equal  issues  of 
each,  the  rate  to  use  would  be  4|  per 
cent.  If  the  issues  are  unlike,  as  four 
parts  of  bonds  to  five  parts  of  stock, 
the  respective  interest  rates  would  be 
weighted  by  the  numbers  expressing  the 
relative  amounts  of  stocks  and  bonds. 
Thus  in  the  case  mentioned  the  weighted 
average  interest  rate  is 

4  x  4  +  5  x  5 


9 


4.555. 


If  the  property  is  not  so  substantial 
and  has  a  less  well-established  credit, 
more  risk  is  involved  in  investment  in  it 
and  the  rate  should  be  higher.  It  may 


VALUATION  133 

be  argued  that  the  rate  at  which  securi- 
ties are  held  in  the  market  has  nothing 
to  do  with  value.  Certainly  the  credit 
of  the  company  depends  upon  the  value 
of  the  property  and  the  character  of  its 
management,  and  the  rate  at  which  its 
securities  are  held  is  some  measure  of 
its  credit. 

Depreciation.  —  A  railroad  property  is 
never  in  100  per  cent  new  condition. 
Even  a  new  road  of  any  magnitude  has 
some  few  elements,  like  ties,  that  begin 
to  deteriorate  as  soon  as  placed  in  the 
track;  rails  begin  to  wear  as  soon  as 
construction  trains  begin  to  run  over 
them.  It  has  not  been  customary  in  the 
past  to  begin  laying  aside  any  moneys 
to  provide  an  offset  to  this  early  wear. 
Indeed,  the  United  States  Supreme  Court 
held  for  thirty  years  that  a  railroad  com- 
pany was  not  entitled  to  set  aside  such 
moneys  in  advance  of  their  actual  need 
and  by  putting  the  sums  in  operating  ex- 
pense collect  them  from  the  public  in 
rates  for  service.  Only  such  expendi- 
tures as  were  actually  made  to  renew  or 


134  WHAT  IS  FAIR 

repair  defective  items  could  be  so  charged 
in  operating  expense.  So  the  custom  of 
replacing  worn-out  items  as  necessary  and 
charging  the  replacement  cost  in  operat- 
ing expense  which  had  already  grown  up 
was  continued,  and  this  custom  is  known 
as  the  replacement  method  of  maintain- 
ing a  property.  Of  course  it  should  be 
the  cost  of  the  retired  item  that  is  charged 
in  operating  expense  and  collected  from 
the  public,  rather  than  the  cost  of  the 
new  item,  because  in  the  latter  case  if 
the  new  item  costs  more  than  the  old,  the 
public  is  contributing  capital  to  the  en- 
terprise in  the  amount  of  the  excess,  and 
if  the  new  item  cost  less  than  the  old  the 
owner  is  losing  capital  to  the  extent  of 
the  deficiency.  The  public  should  not 
be  expected  to  contribute  capital  but  to 
pay  a  return  on  that  contributed  by  the 
owner,  and  to  restore  to  the  owner  the 
amount  of  his  capital  outlay  when  that 
which  was  purchased  with  the  outlay  has 
been  consumed  in  the  service  of  the 
public. 

Then  in  1909  in  a  Water  Works  case, 


VALUATION  135 

which  has  since  been  applied  to  railroads, 
the  Supreme  Court  reversed  itself  and 
decided  that  not  only  has  a  utility  com- 
pany a  right  to  set  aside  a  proper  allow- 
ance for  growing  waste,  charge  it  in 
operating  expense  and  collect  it  in  the 
rates  for  service,  but  that  it  is  the  plain 
duty  of  the  company  so  to  do,  failing 
which  it  may  find  itself  at  a  subsequent 
date,  when  a  valuation  is  made  in  connec- 
tion with  the  settlement  of  some  dispute, 
with  a  depreciated  property  and  no  funds 
to  make  good  the  loss. 

And  unfortunately  some  railroad  com- 
panies have  found  themselves  in  exactly 
this  condition.  Perhaps  this  has  been 
the  result  of  a  failure  of  the  court  to  ap- 
preciate the  real  equities  in  the  case 
because  the  case  was  not  properly  pre- 
sented. Considering  ties,  a  condition 
gradually  comes  about  in  a  normal  prop- 
erty such  that  a  fairly  regular  percentage 
of  ties  is  renewed  each  year,  and  as  at 
any  time  some  would  be  new,  about  an 
equal  number  ready  to  be  discarded,  and 
equal  numbers  in  various  life  conditions, 


136  WHAT  IS  FAIR 

so  the  average  condition  of  all  ties  would 
be  about  50  per  cent  of  condition  new, 
or  they  would  have  served  about  half 
their  composite  life.  Other  parts  of  the 
property  would  be  found  in  condition  less 
than  new,  except  that  earthwork  may  be 
in  even  better  condition  at  a  given  date 
than  when  it  was  new.  As  a  general  re- 
sult the  property  as  a  whole  might  in- 
ventory from  80  to  85  per  cent  new,  or 
it  would  be  said  that  about  15  to  20  per 
cent  of  its  composite  total  life  has  been 
consumed.  Certain  courts  have  accepted 
this  as  indicating  a  loss  of  value  of  the 
physical  property  of  from  15  to  20  per 
cent  of  the  cost.  But  this  is  not  cor- 
rect. The  property  can  never  be  in  bet- 
ter than  normal  condition  for  any  length 
of  time  and  so  far  as  depreciation  is  con- 
cerned it  is  worth  just  as  much  as  it  is 
practically  possible  for  it  to  be  worth  as 
a  going  concern  of  its  class  if  it  is  in 
normal  condition. 

The  Interstate  Commerce  Commission 
still  permits  the  railroads  to  maintain 
their  properties,  except  the  single  class  of 


VALUATION  137 

items  known  as  equipment,  by  the  re- 
placement method;  but  it  requires  tele- 
phone companies  to  set  aside  depreciation 
reserves  right  from  the  beginning  for  all 
wasting  items.  This  is  really  the  best 
practice.  If  the  railroad  companies  had 
been  permitted  to  do  this  and  had  done 
it,  each  would  have  found  itself  eventu- 
ally with  a  fund  of  from  15  to  20  per  cent 
of  the  cost  of  its  property  which  it  could 
use  in  any  one  of  several  ways.  It  could 
return  it  to  the  stockholders  and  reduce 
their  stock  holdings  in  an  equivalent 
amount,  or  it  could  buy  in  and  retire  its 
bonds,  and  the  invested  capital  would 
then  agree  substantially  with  an  80  to  85 
per  cent  estimate  of  value  of  the  prop- 
erty; it  could  build  additions,  thus  main- 
taining the  invested  capital  intact  in 
amount;  or  it  could  provide  betterments, 
which  would  bring  about  the  same  re- 
sult. But  the  railroad  companies  haven't 
set  aside  these  reserves;  it  is  doubtful 
whether  or  not  they  knew  the  necessity 
or  advisability  of  doing  so  in  the  early 
days;  and  whether  or  not  they  wished 


138  WHAT  IS  FAIR 

to  do  so,  they  were  for  thirty  years  pro- 
hibited by  the  United  States  Supreme 
Court  from  doing  so.  In  some  cases  the 
earnings  may  have  been  sufficient  to  per- 
mit setting  aside  for  depreciation  and  pay- 
ment of  reasonable  return,  but  the  earn- 
ings were  distributed  as  dividends  or  in- 
vested in  additions  or  betterments  but 
not  to  offset  depreciation.  Whether  or 
not  this  was  good  public  policy  cannot 
now  be  questioned;  it  was  authorized  or 
permitted  policy.  We  did  not  know  as 
much  then  as  we  know  now.  We  can- 
not correct  the  mistakes  of  the  past  by 
penalizing  the  business  of  the  present. 
It  can  be  of  no  concern  whether  the  prop- 
erty is  in  70  per  cent  condition,  90  per 
cent  condition,  or  practically  100  per  cent 
condition,  provided  it  is  in  normal  con- 
dition and  is  being  kept  so  by  constant 
adequate  expenditures  collected  from  the 
public  and  charged  in  operating  expense, 
so  that  the  cost  of  maintaining  the  whole 
property  in  as  good  condition  as  is  prac- 
tically possible  is  a  deductible  quantity 
when  estimating  net  earnings. 


VALUATION  139 

Certain  very  large  and  costly  items, 
such  as  terminals  in  large  cities,  cannot 
be  properly  maintained  by  the  replace- 
ment method  except  as  to  current  re- 
pairs. A  terminal  costing  $25,000,000  or 
more  is  not  a  permanent  structure  and 
to  replace  it,  as  is  usually  done  with  an 
even  larger  and  more  costly  structure, 
will  generally  require  more  than  a  single 
year,  yet  charging  off  such  a  structure 
through  even  a  period  of  a  few  years  dur- 
ing the  destruction  of  the  old  and  the 
construction  of  the  new  is  likely  to  make 
a  too  large  drain  on  the  surplus  gener- 
ally carried  for  large  emergency  expenses. 
Therefore,  if  there  are  such  property 
items  belonging  to  a  given  property  to 
be  valued,  some  depreciation  should  be 
deducted  from  the  base  value  to  cover 
the  lost  value  due  to  the  estimated  loss 
of  life  considered  as  a  fraction  of  the  es- 
timated total  life.  This  may  be  offset 
by  reserves  if  any  have  been  accumu- 
lated. Companies  owning  such  property 
items  should  make  yearly  provision  from 
earnings  from  the  beginning  for  the  re- 


140  WHAT  IS  FAIR 

tirement  of  the  items.  Whether  or  not 
they  have  been  permitted  to  do  so  would 
make  no  difference  in  the  value  of  the 
property;  but  if  the  public  has  pro- 
hibited the  practice,  it  cannot  in  justice 
penalize  the  company  for  its  failure  to 
do  what  it  was  prohibited  from  doing 
when  the  question  at  issue  is  a  public  one 
involving  the  "fair  value  "  of  the  prop- 
erty. The  amount  of  the  accrued  depre- 
ciation of  the  items  should  have  been 
collected  from  the  public;  if  the  public 
has  refused  to  pay  it  until  the  whole  shall 
mature,  the  sum  is  still  owing  to  the  com- 
pany and  should  be  considered  an  asset 
in  any  public  question  although  it  is  true 
that  the  property  has  lost  value  in  the 
amount  of  the  estimated  accrued  depre- 
ciation. 

When  finding  the  value  of  a  railroad 
property  by  deducting  depreciation  from 
capitalized  net  earnings,  that  sum  should 
be  deducted  which  it  is  estimated  will  be 
required  to  restore  any  abnormally  re- 
duced items  to  normal  condition,  and 
such  further  sum  as  the  estimator  may 


VALUATION  141 

think  necessary  to  cover  accrued  loss  of 
value  of  certain  great  items,  with  costs 
too  large  to  be  charged  off  in  operating 
expense  when  finally  retired  from  service, 
but  in  connection  with  a  public  question 
fair  dealing  may  require  the  latter  loss 
to  be  ignored. 

Depreciation  may  be  estimated  in  dif- 
ferent ways.  For  any  given  item  the 
elapsed  service  life  will  be  known,  and 
the  remaining  service  life  must  be  esti- 
mated, thus  the  total  service  life  is  esti- 
mated. Then  it  will  be  necessary  to 
determine  which  of  two  theories  of  de- 
preciation shall  be  used  to  estimate  the 
loss  of  value  due  to  the  elapsed  service  life. 

1.  It  may  be  assumed  that  loss  of  value 
proceeds  directly  in  proportion  to  age; 
if  half  the  service  life  is  gone,  half  the 
service  value  is  gone.  This  is  known  as 
the  straight  line  theory  of  depreciation. 
Service  value  is  cost  less  salvage  value. 
If  an  item  costing  $1000  and  having  a 
salvage  value  of  $100  has  an  estimated 
service  life  of  twenty  years  and  has  been 
in  use  ten  years,  it  has  lost  &  of  $900  or 


142  WHAT  IS  FAIR 

$450  in  service  value  by  the  straight  line 
theory  and  is  worth  $550  at  the  date  of 
valuation. 

2.  It  may  be  assumed  that  loss  of 
value  proceeds  exactly  in  accordance 
with  the  growth  of  a  properly  computed 
annuity  at  compound  interest.  That  is 
to  say  if  P  dollars  of  value  are  to  be  used 
up  in  N  years,  and  money  is  worth  r 
per  cent,  an  annuity  is  found  from  the 
equation  pr 

1    =(l  +  r)"-l' 

such  that  being  placed  at  r  per  cent  com- 
pound interest  it  will  equal  P  dollars  in 
N  years,  and  the  amount  of  this  annuity 
and  interest  accumulations  at  any  time 
is  assumed  to  be  equal  to  the  loss  of  value 
of  the  item  up  to  that  time.  Applying 
the  theory  to  the  item  used  in  the 
straight  line  illustration  with  respect  to 
which  $900  of  value  is  to  be  consumed 
in  twenty  years  of  which  ten  have  elapsed 
and  if  interest  be  taken  at  5  per  cent 

900  x  0.05 
'(1.05)"°-  1 


VALUATION  143 

and  the  amount  of  this  with  its  interest 
accumulations  is  had  from  the  equation 

8  =  l 


(I  +r)»-l  ' 

9_900(1.05)10-1 

(1.05)20-! 

or  considerably  less  loss  of  value  in  ten 
years  than  is  estimated  by  the  straight 
line  theory.  The  longer  the  life  of  the 
item,  the  greater  is  the  discrepancy  be- 
tween the  two  estimates  and  it  becomes 
a  matter  of  importance  which  shall  be 
used.  That  last  described  is  called  the 
Compound  Interest  Theory  of  Deprecia- 
tion. There  is  another  theory  known  as 
the  Unit  Cost  Theory,  which,  however,  is 
difficult  of  application  particularly  to  rail- 
road property  and  which  takes  into  ac- 
count the  lessened  service  capacity  of  an 
old  item.  If  the  service  capacity  is  con- 
sidered to  be  constant  throughout  the  life 
of  the  item,  the  theory  reduces  to  the  com- 
pound interest  theory,  which  is,  indeed, 
then  a  special  case  of  the  unit  cost  theory. 
Some  engineers  prefer  the  straight  line 


144  WHAT  IS  FAIR 

theory  and  some  the  compound  interest 
theory,  sometimes,  though  less  advisedly, 
called  the  sinking  fund  theory  because 
the  growth  of  depreciation  proceeds  just 
as  a  sinking  fund  accumulates.  Some 
courts  have  adopted  the  straight  line 
theory.  As  the  value  of  the  use  of 
money  should  always  be  considered  it 
would  seem  that  the  compound  interest 
theory  is  the  proper  theory  to  adopt. 
But  in  any  case  if  it  has  been  customary 
to  set  aside  a  reserve  based  on  any  par- 
ticular theory,  it  will  be  fair  to  adopt 
that  theory  for  the  estimate. 

The  total  cost  of  an  item  during  its 
life,  if  the  value  of  the  use  of  money  be 
taken  into  account,  is  exactly  the  same 
whether  it  be  maintained  under  the  re- 
placement method  or  under  a  reserve 
method  in  which  the  bookkeeping  is  by 
either  the  straight  line  theory  or  the 
compound  interest  theory,  and  is  the 
sum  to  which  the  cost  less  salvage  of 
the  item  will  amount  if  placed  at  com- 
pound interest  for  the  life  of  the  item,  or 
C  =  P  (1  +  r)N 


VALUATION  145 

but  the  loss  of  value  proceeds  at  different 
rates  under  the  different  theories. 

Great  difficulty  will  be  found  in  esti- 
mating the  total  lives  of  many  items, 
such  as  bridges,  buildings,  reservoirs,  and 
the  like.  To  get  the  depreciation  each 
item  must  be  inventoried  and  judged  as 
to  its  remaining  useful  life  and  its  sal- 
vage value,  after  which  its  total  service 
life  is  found  by  adding  estimated  remain- 
ing life  and  known  elapsed  life,  the  proper 
interest  rate  and  depreciation  theory  are 
chosen  and  the  depreciation  for  the  item 
computed.  The  total  depreciation  for 
the  property  is  then  found  by  summing 
the  several  item  losses.  As  has  been  ar- 
gued already  the  whole  may  be  more 
than  should  be  deducted  but  this  is  a 
matter  of  equity  to  be  determined  by 
the  court  or  body  of  final  jurisdiction. 

Working  Capital.  -  -  The  property  val- 
ued is  assumed  to  include  the  necessary 
free  capital  in  the  shape  of  supplies  on 
hand,  quickly  convertible  securities  or 
cash  owned  and  necessary  for  current  ex- 
penses and  emergencies.  To  any  extent 


146  WHAT  IS  FAIR 

that  such  working  capital  does  not  go 
with  the  property,  and  must  be  supplied 
by  a  purchaser,  to  the  same  extent  is  the 
value  of  the  property  reduced  below  that 
found  by  the  foregoing  method. 

PUBLIC  REGULATION  BASES 

Return  Base.  —  The  courts  have  said 
that  a  public  utility  corporation  is  en- 
titled to  earn  in  addition  to  operating 
expense  and  depreciation  allowances  a 
"fair  return  "  on  the  "fair  value  "  of  its 
property  used  in  the  public  service. 
Confusion  as  to  the  meaning  of  "fair 
value  "  and  disagreement  as  to  what  con- 
stitutes "fair  return  "  have  caused  much 
difficulty  in  the  application  of  the  law 
thus  laid  down.  Witnesses  have  differed 
widely  in  their  testimony,  commissions 
have  not  judged  alike,  nor  have  the 
courts  agreed  in  their  interpretations. 
"Fair  value  "  does  not  always  mean  the 
same  thing  as  the  value  of  the  preceding 
paragraphs.  The  courts  have  said  that 
the  "fair  value  "  for  estimating  fair  re- 
turn, and  hence  the  reasonableness  of 


VALUATION  147 

rates  producing  the  return,  cannot  be 
capitalized  net  earnings  less  abnormal 
depreciation  and  sometimes  working  cap- 
ital, because  net  earnings  depend  on  the 
very  rates  that  may  be  in  question. 

Therefore  the  courts  have  required 
some  other  quantity  to  be  found  which 
could  be  called  the  "fair  value"  of 
a  property  in  question.  This  quantity 
would  better  be  called  by  another  name 
as,  for  instance,  return  base,  to  save  the 
confusion  arising  from  the  use  of  the 
word  value  in  several  senses.  One  quan- 
tity that  has  been  much  in  favor  as  a 
basis  for  the  estimation  of  the  return 
base  is  "cost  of  reproduction  less  depre- 
ciation "  estimated  as  of  the  day  of  valu- 
ation. Another  basis  that  has  not  been 
used  much  owing  to  an  alleged  difficulty 
of  determination  is  "original  cost  to  date 
less  depreciation  "  -  the  actual  sacrifice 
of  the  owner  in  producing  the  property 
used  in  the  public  service.  It  is  true  that 
owing  to  the  scarcity,  insufficiency,  and 
inaccuracy  of  early  records,  it  is  practi- 
cally impossible  to  find  the  actual  cost 


148  WHAT  IS  FAIR 

to  date  of  a  very  old  property  with  many 
old  items  still  in  use.  But  many,  per- 
haps most,  of  the  items  actually  in  use 
at  a  given  date  will  be  relatively  new 
and  as  it  is  the  cost  of  these  items  —  not 
those  long  ago  used  up  —  that  is  to  be 
found,  it  is  perhaps  fair  to  say  that  esti- 
mated original  cost  to  date  may  be  not 
farther  from  the  truth  than  estimated 
cost  of  reproduction,  which  is  a  term  sub- 
ject to  more  than  one  interpretation. 

Engineers  know  how  to  estimate  in 
advance  the  cost  of  producing  a  new 
railroad,  and  the  principles  involved  in 
estimating  the  cost  of  reproduction  are 
not  different.  Certain  quantities  may  be 
more  exactly  known  than  for  an  advance 
estimate,  but  when  certain  hypotheses 
have  been  agreed  upon  the  procedure  is 
not  different  from  that  of  an  advance  es- 
timate for  a  new  property.  But  these 
hypotheses  are  what  make  trouble.  The 
courts  have  said  that  the  "  value  "  to  be 
determined  is  that  of  the  time  of  valua- 
tion. This  gives  color  to  the  claim  of 
some  that  the  surrounding  physical  con- 


VALUATION  149 

ditions  to  be  assumed  for  the  estimate 
must  be  those  existing  at  the  date  of 
valuation  rather  than  those  existing  when 
the  property  was  created,  and  that  prices 
of  labor  and  materials,  and  methods  of 
doing  work  should  be  those  prevailing 
at  the  date  of  valuation.  Others  recog- 
nizing certain  difficulties  say  that  present 
prices  and  methods  are  to  be  used  but 
with  surrounding  physical  conditions  as 
they  were  when  the  property  was  created. 
Others  take  a  middle  ground  and  say 
that  certain  historic  conditions  must  be 
assumed  and  certain  present  day  condi- 
tions, using  one  or  the  other  in  accord- 
ance with  their  ideas  of  what  is  fair,  or 
would  tend  to  produce  a  fair  result.  A 
few  suggestions  will  illustrate  the  diffi- 
culty of  a  fixed  rule  for  all  cases. 

1  For  the  construction  of  a  railroad 
across  a  deep  valley  having  a  relatively 
insignificant  stream  in  its  bottom,  a  high 
trestle  or  bridge  was  necessary  and  was 

1  Taken  from  the  Report  of  the  American  Society 
of  Civil  Engineer's  Special  Committee.  Proceedings 
for  December,  1916. 


150  WHAT  IS  FAIR 

built  wholly  ' '  in  the  dry. ' '  Later  the  val- 
ley was  converted  into  a  reservoir.  In 
an  estimate  of  the  cost  of  reproduction 
of  the  railroad  as  of  a  given  date  subse- 
quent to  the  building  of  the  reservoir, 
shall  the  cost  of  producing  the  bridge  be 
estimated  on  the  supposition  that  the  val- 
ley is  dry  as  it  was  originally  or  flooded 
with  water  as  it  is  at  the  date  of  valua- 
tion? The  latter  supposition  would  re- 
sult in  a  greater  estimate  than  the  former, 
while  it  should  be  plain  that  the  creation 
of  the  reservoir  has  added  nothing  to  the 
value  of  the  bridge  or  railroad;  indeed 
it  may  be  said,  perhaps,  to  have  lessened 
its  value  owing  to  greater  cost  of  main- 
tenance or  future  replacement. 

Again,  certain  commissions  in  estimat- 
ing cost  of  reproduction  have  considered 
necessary  clearing  and  grubbing  of  the 
right  of  way  to  be  indicated  by  present 
surrounding  conditions;  if  at  the  time 
of  valuation  the  road  is  lined  on  either 
side  by  forest  or  orchard,  clearing  and 
grubbing  will  be  assumed  to  be  neces- 
sary; if  the  land  is  clear  on  either  side 


VALUATION  151 

no  clearing  or  grubbing  will  be  estimated. 
This  is  a  relatively  small  matter  in  the 
country,  but  let  the  same  reasoning  be 
applied  to  a  line  built  into  a  great  city. 
When  the  line  was  built  there  were  no 
houses  of  any  kind  along  its  route  which 
lay  through  open  vacant  fields.  Now 
after  years  of  city  growth  the  right  of 
way  is  lined  on  both  sides  with  costly 
buildings.  Shall  it  be  assumed  in  the  re- 
production estimate  that  such  buildings 
cover  the  right  of  way  and  must  be  pur- 
chased and  wrecked?  None  were  ever 
there. 

The  question  of  land  holdings  has  been 
troublesome.  The  Supreme  Court  of  the 
United  States  has  said  quite  positively 
hi  the  "  Minnesota  Rate  Case  "  that  the 
"  value  "  of  the  right  of  way  —  it  is  not 
quite  clear  whether  the  court  means  the 
estimated  cost  of  reproduction,  but  ap- 
parently not  —  must  be  the  same,  unit 
area  for  unit  area,  as  the  fair  value  of 
similar  adjacent  land  without  addition 
for  cost  of  acquisition  or  overhead  ex- 
pense, or  damages.  And  yet  the  court 


152  WHAT  IS  FAIR 

seems  to  indicate  in  its  decision  that  in 
a  valuation  it  would  accept  cost  as  de- 
termined by  the  well-known  methods  of 
condemnation  under  the  right  of  eminent 
domain  as  reasonable  measure  of  "fair 
value.77  Now  it  is  a  well-settled  prin- 
ciple of  law  that  the  price  to  be  paid  for 
a  piece  of  land  when  taken  by  condem- 
nation, and  when  less  than  the  whole  of 
a  given  parcel  is  taken,  is  the  fair  value 
of  the  portion  taken  plus  the  damage 
caused  by  the  taking  to  the  part  not 
taken  —  known  as  severance  damage  — 
and  such  takings  always  involve  certain 
costs  of  acquisition. 

At  present  the  whole  matter  of  esti- 
mating land  values  for  railroad  right  of 
way  is  in  an  unsettled  condition,  there 
being  those  —  though  not  the  higher 
courts  —  who  hold  that  donated  lands 
should  not  be  included  in  the  company's 
property  estimates,  even  though  it  may 
be  argued  that  it  is  highly  probable  that 
the  company  has  fully  paid  for  those 
lands  in  early  losses,  and  that  whether 
or  not  it  has,  a  gift  is  as  much  the  prop- 


VALUATION  153 

erty  of  the  person  receiving  it  as  the 
same  article  would  be  if  purchased  for 
money.  Only  under  the  conception  that 
the  company  is  the  agent  of  the  public 
and  holds  its  property  much  as  if  it  were 
property  of  the  public  held  in  trust  by 
the  company,  can  donated  property  be 
held  out  of  a  valuation.  This  relation- 
ship of  agency  is  not  endorsed  by  the 
courts. 

The  right  to  much  right  of  way  is 
but  an  easement  permitting  the  use  of 
the  property  for  railroad  purposes  only 

-  the  company  does  not  own  the  fee. 
Under  a  variety  of  assumptions  and  with 
much  uncertainty,  one  can  estimate  what 
it  would  cost  now  to  get  these  right-of- 
way  easements,  but  would  this  seem  to 
be  a  fair  estimate  of  the  sacrifice  of  the 
owners  for  this  particular  item,  is  it  a 
fair  or  proper  measure  of  "fair  value  " 

-  return  base? 

1  A  railroad  was  built  through  a  heavily 

1  Taken  from  the  Report  of  the  American  Society 
of  Civil  Engineer's  Special  Committee.  Proceedings 
of  December,  1916. 


154  WHAT  IS  FAIR 

timbered  territory  and  paid,  say,  $40 
an  acre  for  its  right  of  way,  and 
$40  to  $50  more  for  clearing  and  grub- 
bing. Its  principal  business  for  many 
years  was  hauling  lumber.  Eventually 
the  surrounding  territory  was  cleared. 
Settlement  by  farmers  did  not  develop. 
No  prosperous  towns  grew  up,  but  by 
establishing  a  through  connection,  the 
road  managed  to  keep  its  earnings  up 
and  hence  its  value.  The  surrounding 
land  is  now  worth  perhaps  $5  an  acre 
and  there  would  be  no  cost  for  clearing 
were  a  new  road  to  be  built  along  side 
the  present  road.  Should  the  cost  of  re- 
production estimate  for  the  right  of  way 
be  based  on  the  original  or  the  present 
conditions?  And,  if  on  the  present  con- 
ditions, is  the  cost  of  reproduction  a  fair 
measure  of  the  value  of  the  property  on 
which  to  base  a  fair  return  rate? 

A  large  item  of  expense  in  creating  a 
great  property  is  the  item  of  interest 
during  construction  and  early  develop- 
ment. A  new  company  promoting  a 
new  property  will  have  to  pay  a  high 


VALUATION  155 

rate  for  money.  Including  discounts  and 
bonuses,  it  is  often  more  than  10  per  cent. 
A  well-established  company  earning  a 
good  return  can  borrow  money  for  5  per 
cent  or  less.  Shall  the  interest  rate  to 
be  used  in  estimating  the  cost  of  re- 
production be  that  of  a  new  company 
promoting  a  new  property  or  that  obtain- 
able by  the  present  prosperous  owners  of 
the  property  to  be  valued? 

One  engineer  desires  to  make  his  esti- 
mate of  cost  of  reproduction  in  such  a 
way  that  the  court  will  accept  it  as  a 
basis  of  value;  another  wishes  to  make 
an  estimate  of  reproduction  as  of  a  given 
date  in  accordance  with  his  notion  of  the 
logic  of  the  requirement  and  without  re- 
gard to  whether  all  of  the  several  items 
included  in  the  estimate  are  properly 
items  to  be  included  in  the  return  base 
or  "fair  value."  Some  engineers,  some 
courts,  and  some  commissions  seem  to 
think  that  the  logic  of  the  requirement 
means  an  estimate  based  on  presently  ex- 
isting physical  conditions  at  and  around 
the  property,  present  prices  for  materials 


156  WHAT  IS  FAIR 

and  labor  and  present  methods  of  doing 
work.  Those  who  would  make  the  esti- 
mate conform  as  nearly  as  possible  to 
what  the  court  will  finally  call  "fair 
value,"  that  present  prices  and  methods 
must  be  used  with  historic  conditions. 

There  are  others,  who  feel  that  an  esti- 
mate of  cost  of  reproduction  as  of  a  given 
day  should  be  based  on  present  prices  of 
land,  labor,  and  materials,  and  present 
conditions,  except  that  the  history  of  the 
property  should  be  consulted  to  deter- 
mine those  elements  of  cost,  the  evidence 
of  which  was  destroyed  by  the  creation 
of  the  property,  and  which  it  would  be 
reasonable  to  suppose  would  still  be  nec- 
essary elements  of  cost  of  a  new  prop- 
erty like  that  in  question  constructed  on 
the  site  of  the  existing  property,  if  that 
property  had  not  been  created;  and  that 
all  such  elements  of  cost  should  be  in- 
cluded. This  theory  seems  to  be  the 
most  logical  theory  on  which  to  base  an 
estimate  of  the  cost  of  reproduction  as 
of  a  given  date,  but  it  is  recognized  that 
the  result  less  proper  depreciation  is  not 


VALUATION  157 

always  the  proper  measure  of  the  return 
base  or  "  fair  value  "  of  an  old  property. 

There  are  so  many  differences  with 
respect  to  the  several  questions  that 
have  been  raised  in  the  preceding  para- 
graphs that  the  propriety  of  using  cost 
of  reproduction  new  less  depreciation  as 
a  base  for  "fair  value  "  or  proper  return 
base  for  an  old  property  seems  question- 
able. What  should  be  determined  upon 
finally  should  be  that  which  is  fair,  and 
the  following  suggestions  are  offered  with 
respect  to  new  properties  assumed  to  be 
successful,  old  successful  properties,  and 
old  unsuccessful  properties. 

New  Property.  —  The  fair  reasonable 
cost  including  a  proper  working  capital  is 
the  best  base  on  which  to  estimate  and 
fix  the  fair  rate  of  return.  The  service 
rate  allowed  should  be  such,  if  possible, 
that  it  will  not  be  necessary  to  raise  the 
rate  after  a  little  to  cover  fair  return  on 
the  early  deficiencies  that  may,  and  prob- 
ably will,  occur  and  should  be  added  to 
the  return  base  as  they  accrue.  This  is 
not  the  place  to  argue  as  to  the  proper 


158  WHAT  IS  FAIR 

rate  of  return;  that  argument  has  been 
made  already.  Let  it  be  repeated,  how- 
ever, that  the  rate  must  be  large  enough 
to  attract  private  capital  or  the  public 
will  have  to  serve  itself  or  go  without 
service.  And  with  respect  to  railroad 
property  it  should  be  noted  that  par- 
ticular rates  must  always  be  made  for 
particular  services  largely  if  not  entirely 
without  consideration  of  rate  of  return 
on  capital.  Some  service  must  be  ren- 
dered at  a  loss,  and  to  offset  this,  other 
service  must  be  at  a  rate  that  by  itself 
is  exhorbitantly  profitable,  though  well 
within  what  the  traffic  will  bear.  This 
is  necessary  in  order  that  the  greatest 
benefit  may  be  rendered  to  the  greatest 
number  and  general  progress  encouraged. 
The  net  result  to  the  company  for  its 
whole  service  should  be  a  fair  rate  of 
return  on  the  fair  cost  of  its  property 
and  a  fair  profit  or  wage  for  the  service 
rendered. 

Old  Successful  Property.  —  Again  it  is 
what  is  fair  between  the  people  served 
and  the  serving  company  that  should 


VALUATION  159 

govern  in  the  determination  of  fair  re- 
turn base.  Here  the  courts  have  said 
more  than  once  that  it  is  not  cost  but 
present  value  that  must  be  used.  There 
is  no  real  measure  of  value  of  an  old  go- 
ing business  but  accumulated  reasonably 
certain  earning  capacity.  But  shall  the 
corporation  have  all  the  earning  capacity 
that  it  has  acquired  under  past  regula- 
tion or  no  regulation?  Is  this  fair?  And 
if  it  is,  could  rates  ever  be  reduced  by 
law?  Could  the  "fair  value"  of  a  suc- 
cessful old  property  ever  be  more  than 
capitalized  net  earnings  less  deferred 
maintenance  and  properly  deductible  de- 
preciation? The  courts  have  held  that 
the  company  is  entitled  in  a  return  base 
to  every  element  of  value  that  it  has 
acquired  that  represents  usefulness  in  its 
service,  but  not  to  the  earning  capacity 
element,  which  would  seem  to  be  the 
only  thing  of  great  value  that  has  been 
acquired.  The  physical  properties  are  of 
value  above  salvage,  no  matter  what  they 
cost,  only  as  they  enable  the  owner  to 
earn  something  for  himself,  and  the  earn- 


160  WHAT  IS  FAIR 

ing  —  usually  called  interest  or  return  — 
capitalized  is  the  measure  of  that  value. 
The  earnings  of  a  single  month  must  not 
be  used,  nor  yet  those  of  a  single  year, 
but  rather  must  the  earnings  of  several 
years  be  examined,  and  a  prophecy  for  a 
reasonably  short  future  —  say  five  years 
-  should  be  made,  that  the  effect  of  brief 
extraordinary  conditions  may  be  elimi- 
nated or  averaged  into  the  whole. 

It  would  certainly  seem  to  be  fair  to 
allow  the  company  whatever  it  has  ac- 
cumulated lawfully  under  such  regula- 
tion as  may  have  been  exercised.  If 
there  has  been  no  regulation  or  defective 
regulation,  this  is  the  fault  of  the  public 
for  which  the  company  with  its  possible 
many  investors  should  not  be  made  to 
suffer.  If  the  company  has  also  been  at 
fault  the  matter  is  to  be  adjudicated. 
And  in  spite  of  the  assertions  of  courts 
to  the  contrary,  the  adoption  of  fair  pres- 
ent earning  capacity  as  the  basis  for  value 
or  return  base  will  not  always  result  in 
reasoning  in  a  circumference,  because  al- 
most all  successful  properties  are  growing 


CdA. 

pre 


VALUATION  161 

and  in  almost  all  cases  where  unwise 
regulation  has  not  made  earnings  too  low, 
earnings  are  normally  increasing  under 
sent  rates  for  service.  Rates  then 
may  be  reduced  to  keep  the  future  rate 
return  on  the  presently  determined 
ue  stationary  and  to  provide  a  speci- 
rate  of  return  on  all  new  capital  that 
ay  be  invested  in  the  property.  This 
uld  not  be  a  simple  matter  —  no  leg- 
ature  could  off-hand  enact  a  two  cent 
a  one  cent  law.  Action  should  be  had 
ly  after  the  most  careful  examination, 
alysis,  and  recommendation  by  a  corn- 
tent  commission. 

Mistakes  would  be  made  in  any  event 
d  prescribed  rates  might  prove  too  low 
too  high.  But  regulations  could  be 
made  to  cover  such  discrepancies  as  they 
might  occur.  In  some  cases  cost  of  re- 
production less  depreciation  figured  on 
any  reasonable  set  of  hypotheses  would 
be  larger  than  value  based  on  earnings; 
in  other  cases  it  would  be  less. 

While  these  ideas  are  here  set  forth  as 
sound,  it  is  realized  that  many  wise  men 


162  WHAT  IS  FAIR 

have  held  to  cost  of  reproduction,  or 
original  cost  to  date,  as  better  return 
bases  than  value  as  here  defined,  and 
that,  indeed,  as  has  been  said  already, 
value  measured  by  earning  power  is  not 
allowed  by  the  courts  in  rate  cases.  Thus 
the  interested  engineer,  owner,  or  com- 
missioner should  study  this  matter  with 
great  care  getting  such  arguments  as  he 
can  from  published  books,  papers,  and 
court  decisions,  but  finally  making  up  his 
own  mind  as  to  what  is  fair.  The  final 
decision  will  always  be  with  a  court. 
This  one  additional  statement  may  be 
made: 

No  corporation  serving  the  public  should 
be  made  to  feel  that  its  property  is  of  un- 
certain value  due  to  intermittent  regulation 
of  rates  according  to  no  fixed  rule. 

If  the  return  is  to  be  limited  in  any 
way  by  public  regulation,  then  when  this 
is  first  undertaken  for  an  old  property, 
the  value  acquired  to  the  date  of  action 
should  be  allowed,  and  a  method  of  reg- 
ulation, automatic  so  far  as  possible  in 
its  action,  should  be  adopted  for  the 


VALUATION  163 

future.  For  a  new  company  the  same 
procedure  should  be  had,  but  here  the 
return  base  is  the  fair  and  reasonable 
sacrifice  of  the  owner  in  creating  the 
property. 

Old  Unsuccessful  Property.  —  An  un- 
successful property  will  be  defined  to  be 
one  which  with  such  management  as  it 
has  had,  under  such  regulation  or  lack 
of  regulation  as  has  prevailed,  has  been 
unable  to  earn  a  fair  rate  of  return  on  the 
sacrifice  of  its  owners  in  creating  the 
property.  This  does  not  mean  reproduc- 
tion cost  but  original  cost  to  date.  The 
property  need  not  be  failing  to  be  un- 
successful, it  has  only  to  be  earning  less 
than  a  fair  rate  of  return.  It  ought  to  be 
clear  that  if  the  deficiency  is  due  to  the 
public  regulation,  rates  should  be  estab- 
lished at  once,  if  possible,  such  as  to 
/,vield  a  fair  return  on  the  sacrifice  of  the 
o>>wners  including  the  past  deficiencies  of 
earnings  below  an  agreed  fair  rate  on  the 
original  and  growing  sacrifice.  It  might 
be  fair  to  base  the  return  on  cost  of  re- 
production but  certainly  not  on  value. 


164  WHAT  IS  FAIR 

If  the  regulation  has  not  affected  the 
return  but  the  property  has  been  either 
mismanaged  or  wisely  or  unwisely  built 
ahead  of  the  growth  of  an  adequate 
traffic,  the  property  cannot  be  valued  for 
a  return  base  at  its  present  value.  The 
only  fair  return  base  would  seem  to  be 
the  sacrifice  of  the  owners,  and  it  may 
easily  happen  that  no  rate  under  which 
traffic  will  move,  will  yield  a  fair  return 
on  this  investment.  For  the  time  being, 
then,  the  value  of  the  property  as  a  going 
concern  is  small,  nothing,  or  less  than 
nothing  if  the  service  must  be  continued, 
but  the  proper  return  base  is  at  least  the 
sacrifice  of  the  owners. 

If  the  property  cannot  be  made  under 
freedom  of  charges  to  earn  at  least  some 
return  on  the  sacrifice,  it  will  be  a  failing 
venture,  though  if  it  can  earn  operating 
expenses  including  depreciation,  it  may 
be  said  to  have  some  value  in  possible 
future  growth  of  business.  If  under 
freedom  of  charge  it  cannot  earn  oper- 
ating expense,  and  there  is  no  prospect 
that  it  will  be  able  to  do  this  in  the 


VALUATION  165 

reasonably  near  future,  it  is  practically 
worthless  and  should  be  sold  for  such 
salvage  as  may  be  had.  There  is  but  a 
small  mileage  of  this  class  of  railroad 
property  in  America. 

Public  Purchase  Base.  —  If  the  public 
proposes  to  take  over  a  public  utility 
property,  it  should  pay  the  owner  the 
value  of  the  property,  and  possibly  more. 
If  the  property  is  a  normal  successful 
property,  the  purchase  price  should  be 
the  value  at  the  time  of  purchase.  If  the 
property  cannot  earn  a  fair  return  on  the 
sacrifice  of  its  owners  and  this  is  not  the 
result  of  unwise  regulation,  and  the  prop- 
erty is,  therefore,  either  less  than  success- 
ful or  wholly  a  failing  venture,  it  should 
be  noted  that  the  public  has  not  under- 
written the  enterprise  and  hence  is  under 
no  obligation  to  pay  more  than  the  value, 
which  may  be  negative,  unless  it  desires 
the  service  maintained,  in  which  case  the 
purchase  price  should  be  the  proper  and 
reasonable  sacrifice  of  the  owners  to  cre- 
ate the  property  less  accrued  deprecia- 
tion resulting  from  an  abnormal  condi- 


166  WHAT  IS  FAIR 

tion,  but  whether  more  than  this  to  com- 
pensate them  for  their  operation  losses 
or  to  give  a  contractor's  profit  may  be  a 
question  of  business  ethics  to  be  settled 
in  each  particular  case.  It  would  seem 
to  be  clear  that  if  the  corporation  has 
undertaken  the  project  of  its  own  free 
will  and  without  inducement  on  the  part 
of  the  public,  then  the  public  has  neither 
a  legal  or  moral  obligation  to  make  good 
the  losses,  it  will  do  its  part  if  it  relieves 
the  corporation  from  the  burden  of  further 
losses.  Of  course,  if  the  early  charter  or 
franchise  has  provided  a  means  or  method 
for  finding  the  purchase  price,  that  means 
or  method  will  be  followed.  If  the  prop- 
erty is  a  new  property  not  yet  earning 
at  its  normally  expected  rate,  the  proper 
purchase  price  should  be  the  proper  and 
reasonable  sacrifice  of  the  owners  to  the 
date  of  purchase,  plus  a  contractor's 
profit. 

Capitalization  Base.  —  The  "fair 
value "  or  base  for  allowed  capitaliza- 
tion of  a  new  property  should  be  the 
same  as  the  return  base  of  such  a  prop- 


VALUATION  167 

erty,  i.e.,  the  total  actual  and  estimated 
sacrifice  of  the  owners  up  to  the  esti- 
mated time  when  the  property  will  be  a 
normal  going  concern  earning  a  fair  re- 
turn. 

If  the  property  is  an  old  one  and  suc- 
cessful, the  capital  base  is  less  important 
unless  the  public  proposes  to  limit  sharply 
the  rate  of  return.  In  this  case  the  capi- 
tal base  should  be  found  in  the  same  way 
as  the  exchange  value,  but  the  capital- 
izing rate  should  be  the  average  fair  re- 
turn rate,  for  it  must  be  assumed  that 
no  reasonable  regulating  body  will  ever 
limit  fair  rate  of  return  to  a  single 
rate.  There  must  be  a  minimum  rate 
for  lean  years  and  a  maximum  rate 
for  fat  years,  any  return  between  the 
two  being  considered  fair;  any  return 
below  the  minimum  being  too  low  and 
calling  for  a  larger  return  later  or  an 
addition  to  capital,  and  any  return 
above  the  maximum  being  unreasonably 
large  and  one  that  calls  for  some  ad- 
justment or  crediting  of  the  surplus  to 
the  public. 


168  WHAT  IS  FAIR 

Taxing  Base.  —  The  base  for  taxation 
cannot  be  defined  because  it  must  con- 
form to  the  laws  of  the  various  states. 
A  suggestion  may  be  made,  however, 
that  in  so  far  as  a  railroad  is  considered 
to  be  a  private  property,  it  is  at  present 
subject  to  taxation  and  should  be  taxed 
exactly  as  other  manufacturing  property 
is  taxed.  It  may  be  further  suggested 
that  if  taxed,  much  simplicity  would  re- 
sult if  only  its  income  were  taxed  as  a 
whole  and  the  tax  distributed  according 
to  some  properly  worked  out  plan  to  the 
several  states  and  subordinate  political 
divisions  through  which  the  road  passes. 
This  would  mean  federal  control  of  all 
interstate  roads  with  respect  to  taxes, 
and  this  would  conform  to  the  growing 
idea  that  complete  control  of  interstate 
roads  should  be  with  the  federal  govern- 
ment. It  is  suggested  elsewhere  that 
utility  corporations  should  not  be  taxed, 
but  that  their  distributed  net  earnings 
should  be  taxed. 

Conclusion.  -  -  No  attempt  has  been 
made  to  set  forth  details  of  valuation 


VALUATION  169 

work.  The  attempt  has  been  rather  to 
present  what  seem  to  be  just  and  proper 
general  principles  that  should  be  in  the 
minds  of  the  engineer,  the  jurist,  and  the 
business  man,  when  considering  the  valu- 
ation of  a  public  utility,  to  be  made  in 
connection  with  some  question  of  public 
regulation. 

It  seems  to  be  necessary  and  proper 
that  there  shall  be  wise  and  intelligent 
public  control  of  public  utilities,  but  it 
may  be  doubted  whether  it  is  wise  to 
try  to  regulate  rates  for  service  so  as  to 
provide  just  a  fair  return  on  the  fair 
value  of  railroad  properties.  Whether 
or  not  a  particular  rate  is  such  as  to 
yield  a  fair  return  on  the  fair  value  of 
the  property  used  in  the  particular  serv- 
ice is  in  general  impossible  of  ascertain- 
ment. It  may  be  possible  to  determine 
whether  passenger  earnings  as  a  whole 
are  sufficient  to  pay  a  fair  return  on  the 
portion  of  the  property  used  hi  the  pas- 
senger service  but  even  this  is  quite  diffi- 
cult. Similarly  it  may  be  possible  but 
difficult  to  do  the  same  thing  for  freight 


170  WHAT  IS  FAIR 

earnings  as  a  whole.  The  idea  some- 
times advanced  that  every  service  should 
pay  for  itself  is  thought  to  be  unsound. 
It  may  be  entirely  proper  to  handle  some 
business,  that  could  not  afford  to  pay 
more,  even  at  a  loss  if  thereby  some 
greater  business  that  can  and  will  afford 
a  good  return  is  encouraged  and  devel- 
oped. It  has  certainly  been  good  policy 
for  pioneer  roads  to  favor  passenger  traf- 
fic, particularly  of  immigrants,  to  build 
up  the  territory  adjacent  to  their  lines, 
and  there  are  very  many  other  justifiable 
practices  that  can  be  cited.  Moreover, 
as  has  been  pointed  out  in  a  previous 
chapter,  parallel  lines  with  varying  char- 
acteristics and  earning  capacities  and  the 
close  interrelation  of  many  roads  intro- 
duce many  complications.  If  the  regu- 
lation shall  see  that  there  is  no  unjust 
discrimination  in  rates  or  service  as  be- 
tween individuals  or  territories  served, 
the  rates  quite  generally  may  be  left  to 
take  care  of  themselves  otherwise. 

But  if  the  earnings  as  distinguished 
from  rates  are  to  be  regulated  and  kept 


VALUATION  171 

within  certain  supposedly  fair  limits, 
then  it  is  submitted  that  the  practice 
here  advocated  with  respect  to  return 
base  is  fair  as  between  the  public  and  the 
corporation. 


AFTERWORD 

Whatever  may  be  the  opinion  of  the 
reader  who  has  reached  this  point  as  to 
the  correctness  of  the  positions  taken  in 
what  precedes,  the  Author  hopes  that  it 
has  been  his  privilege  to  say  something 
that  will  arouse  thought,  opposition,  if 
necessary,  to  the  end  that  more  men 
whether  utility  owners,  utility  agents,  or 
citizens  served,  when  discussing  public 
utility  questions  will  quietly  ask  "What 
is  fair  in  this  matter?  "  and  will  proceed 
to  think. 

It  makes  no  difference  whether  the 
question  at  issue  seems  to  be  between  a 
greedy  corporation  and  a  greedy  public, 
a  greedy  corporation  and  a  fair  public,  a 
fair  corporation  and  a  greedy  public,  or 
a  fair  corporation  and  a  fair  public,  and 
we  have  known  of  all  these  combinations, 
the  final  decisions  of  all  questions  not 
determined  by  law  should  conform  to  cor- 
rect answers  to  the  one  question,  "What 
is  Fair?  " 

172 


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